Risks, Benefits, and Challenges in Global IT Outsourcing: Perspectives and Practices

IDEA GROUP PUBLISHING ITJ3212 701 E. Chocolate Avenue, Suite 200, Hershey PA 17033-1240, USA Tel: 717/533-8845; Journal Fax of 717/533-8661; Global Information URL-http://www.idea-group.com Management, 14(3), 39-69, July-September 2006 39 This paper appears in the publication, Journal of Global Information Management, vol. 14, issue 3 edited by Felix B. Tan 2006, Idea Group Inc. Risks, Benefits, and Challenges in Global IT Outsourcing: Perspectives and Practices Subhankar Dhar, San Jose State University, USA Bindu Balakrishnan, San Jose State University, USA ABSTRACT Many large organizations are increasingly outsourcing their IT functions. Factors like lower costs, improved productivity, higher quality, higher customer satisfaction, and ability to focus on core areas are some of the benefits of outsourcing. However, there are many challenges and risks associated with IT outsourcing. In this article, we identify the main risk factors and best practices in global IT outsourcing. In addition, we delve into some important issues on IT outsourcing, particularly the challenges along with benefits. Finally, we present case studies of two Global 200 organizations and validate some of the claims made by previous researchers on IT outsourcing. This study will help the management to identify the risk factors and take the necessary remedial steps. Hence, this study is timely and relevant from both an academic and a practitioner s perspective. Keywords: benefits; global outsourcing; risks; transaction cost theory INTRODUCTION In today s global economy, outsourcing has become a very common phenomenon. Many large organizations have outsourced some or all of their IT functions. Factors like lower costs, improved productivity, higher quality, higher customer satisfaction, time to market, and ability to focus on core areas are some of the benefits of outsourcing. However, there are many challenges and risks associated with IT outsourcing (Adeleye, Annansingh, & Nunes, 2004; Alvares et al., 1995; Bahli & Rivard, 2003; Beamish, Marcolin, & Mclellan, 1995; Cross, 1995; Dibbern & Goles, 2004; Feeny, Lacity, & Willcocks, 1995; Lacity & Willcocks; 1995, Lee, Huynh, Kwok, & Pi, 2003; Nam, Rajagopalan., Rao, & Chaudhury, 1996; Rothman, 2003; Sabherwal, 2003). IT Outsourcing is as an act of delegating or transferring some or all of the IT related decision making rights, business processes, internal activities, and services to external providers, who develop, manage, and administer these activities in accordance with agreed upon deliverables, performance standards and outputs, as set forth in the contractual agreement (Dhar, Gangurde, & Sridar, 2004). Whenever, there is an outsourcing decision, there is an inherent risk associated with it. In addition, in any outsourcing deal, there are

40 Journal of Global Information Management, 14(3), 39-69, July-September 2006 some hidden costs, unexpected outcomes, diminishing service levels, to name a few (Antonucci, Lordi, & Tucker, 1998; Aubert, Patry, Rivard, & Smith, 2001; Clark, McCray, & Zmud, 1995; Earl, 1996; King & Malhotra, 2000; Lacity & Hirschheim, 1993). There are four major aspects of the proposed research that are summarized by the following questions: 1. What are the objectives for outsourcing? 2. What are the major factors that contribute to risk in global offshore IT outsourcing? How do we minimize the risk in IT outsourcing projects? 3. What are best practices for outsourcing? 4. How do we validate some of the assumptions made by prior research? Although there are quite a number of studies that address the risk factors and hidden costs in outsourcing, we found out that there is no single study that takes a comprehensive approach in analyzing the issues like risks, benefits, challenges, and best practices in the context of global outsourcing. In addition, many of the important risk factors are not properly analyzed that are quite important to global outsourcing. Of particular interest to us are the effects of risk assessment factors like geographical location, political, cultural, quality standards, legal contracts, and intellectual property as many of these are not well studied and well documented before. These are some of the motivating factors behind this study where we address not only the risks and benefits but also the challenges and best practices along with two case studies and validate some of the claims made by previous researchers on IT outsourcing. Hence, this research fills the gap in the current literature with regards to risk assessment factors in offshore outsourcing in a global context. This article presents case studies of two Global 200 organizations and validates some of the claims made by previous research on IT outsourcing. Our main contribution in this article is to identify sixteen different risk assessment factors that are quite sensitive to global IT outsourcing. In addition, we also analyzed two large organizations (FIRM-1 and FIRM-2) that are currently outsourcing their IT functions and identify the objectives, key benefits, important risk factors, challenges, and best practices. We also found how Transaction Cost Theory has played an important factor in the decision making process for outsourcing. This research is unique in the sense that it analyzes two multinational organizations FIRM -1 and FIRM-2 that are involved in outsourcing for quite sometime and the outsourcing work is done on remote offshore locations in India, China and some other countries in Asia. So this study is truly global in nature as both the organizations conduct business in various parts of the world including the Americas, Europe, Asia, and Australia and in some parts of Africa. In addition, FIRM-1 is one of the suppliers of FIRM-2. Thus both organizations have common goals of making their global supply chain successful, and maximizing the overall profitability. Finally, we do a comparison of each of these factors for both the organizations. Hence, this study is timely and relevant from both an academic and a practitioner s perspective. THEORETICAL CONCEPTS BEHIND OUTSOURCING There are various theoretical justifications for outsourcing. The most popular ones are Transaction Cost Theory (TCT) (Ang & Straub, 1998; Williamson, 1985), Agency theory (Bahli & Rivert, 2003) and Coordination theory (Sabherwal, 2003) to name a few. We have chosen TCT over other theories in this research because a careful analysis of the two cases revealed that TCT was the basis for their outsourcing decision. Transactional Cost Theory A goal of the organizations is to reduce cost and to achieve cost efficiency (Aubert et al., 2001; Diromualdo & Gurbaxani, 1998). Keeping that in mind, Williamson developed the

Journal of Global Information Management, 14(3), 39-69, July-September 2006 41 Transaction Cost Theory (TCT). Transaction costs are related to the effort, time, and costs associated with searching, creating, negotiating, monitoring, and enforcing a service contract between buyers and suppliers. As per Williamson, there are two types of costs involved for any service production costs, and coordination cost. Production cost is the cost incurred to make the product or to provide the service. It includes the cost of labor, material, and capital. Coordination costs include monitoring, controlling and managing the work internally. If the job is handed over to external vendor, the coordination costs are called transaction costs. As per Williamson (1985) transaction cost theory depends on the following parameters: 1. Costs: There are two types of costs associated with any service or product: Production cost Transaction cost Williamson argues externally outsourcing of work results in lower production costs than doing it internally due to economies of scale. But in such a case the transaction cost is high because vendors need to be managed and monitored. In an in-house arrangement, production cost is high because it is difficult to achieve economies of scale. But at the same time, the transaction cost is low because of low coordination costs. 2. Asset specificity: It is defined as the degree of customization of the transaction. It could be site specificity, physical asset specificity, or human asset specificity. High asset specificity results in high transaction. Also the production cost goes up with high asset specificity because specific assets have limited utility in other markets (Hirschheim & Lacity, 1993). 3. Opportunism threat: When the work is given to an external vendor, coordination costs increase because quite possibly the vendor may be opportunistic. Hence, managing and monitoring the vendor becomes more difficult. But when the work is done internally coordination costs are low because the workers may be less opportunistic. Vendors also become opportunistic when there is competition in the market, and when there are a less number of vendors (Hirschheim & Lacity, 1993). When there are only few vendors in the market, organizations looking for such vendors cannot bargain much. Organization may not save much by outsourcing because the vendor may charge excess or may not perform as promised. All these lead to high transaction cost. 4. Uncertainty: Williamson outlines that uncertainty increases the transaction cost. Transaction cost goes up especially for asset-specific investments, under uncertain conditions (Hirschheim & Lacity, 1993). Thus, all these parameters should be weighed well to make a decision. A detailed analysis and trade-off study should be carried out before making an outsourcing decision. RISK DEFINED Risk and risk management have been widely studied in various contexts, such as Finance, Economics, Insurance, Healthcare, Operations Research, and Engineering. Each discipline has its own way of analyzing and interpreting risks. This section elaborates the main issues of risks and presents our perspectives on issues related to risks. Risk as an undesirable event. According to Levine and Schneider (1997, p. 38), risk is events that, if they occur, represent a material threat to an entity s fortune. Using this approach, risk can be interpreted as occurrence of undesirable events. a. Risk as a probability function: In some disciplines, risk is defined as the probability of an event. It is the chance of serious adverse outcome (Bahli & Rivard, 2003).

42 Journal of Global Information Management, 14(3), 39-69, July-September 2006 Table 1. IT outsourcing risk exposure Undesirable outcomes Factors leading to outcome Unexpected transition and Lack of experience and expertise to the client with the activity (Earl, 1996; management costs (Cross, Lacity et al., 1995) 1995; Earl, 1996; Nelson Lack of experience of the client with outsourcing (Earl, 1996) et al., 1996) Uncertainty about the legal environment Switching costs (including Asset specificity (Williamson, 1985) lock-in, and repatriation Small number of suppliers (Nam et al., 1996) and transfer to another Scope supplier) (O Leary, 1990) Interdependence of activities Costly contractual Uncertainty (Alchian & Demsetz, 1972; Barzel, 1982) amendments (Earl, 1996) Technological Discontinuity (Lacity et al., 1995) Task complexity Disputes and litigation Measurement problems (Alchian & Demsetz, 1972; Barzel, 1982) (Aubert et al., 1997; Lack of experience and expertise of the client and/or of the supplier with Lacity & Hirschheim, outsourcing contracts (Earl, 1996; Lacity et al., 1995) 1993) Uncertainty about the legal environment Poor cultural fit Service debasement Interdependence of activities (Aubert et al., 1997; Langonis & Robertson, (Lacity & Hirschheim, 1992) 1993) Lack of experience and expertise of the supplier with activity (Earl, 1996) Supplier size (Earl, 1996) Supplier financial stability (Earl, 1996) Measurement problems (Alchian & Demsetz, 1972; Barzel, 1982) Task Complexity Cost escalation (Lacity & Lack of experience and expertise of the client with contract management Hirschheim, 1993; Lacity (Earl, 1996; Lacity et al., 1995) et al., 1995) Measurement problems (Alchian & Demsetz, 1972; Barzel, 1982) Lack of experience and expertise of the supplier with activity (Earl, 1996) Loss of organizational Scope competencies (Earl, 1996; Proximity of the core competencies (Hamel and Prahalad, 1990) Lacity et al., 1995) Interdependence of activities Hidden service costs Complexity of the activities (Lacity & Hirschheim, Measurement problems (Alchian & Demsetz, 1972) 1993) Uncertainty (Barzel, 1982) Cost of delayed delivery / Vendor fails to deliver as per contract (Bahli & Rivard, 2003) non-delivery Delayed delivery due to unexpected change in the requirements Poor quality and Inability to control vendor s technical quality (Sabherwal, 2003) reliability Loss of control over vendor s technical quality Damages due to security Security requirements practices (Adeleye et al., 2004) breach Intellectual property protection Privacy concerns Loss due to disasters and Loss of control over disaster recovery (Dibbern & Goles, 2004) recovery costs Loss of data and information Loss due to vendor s Vendor becomes competitor opportunism, including Vendor takes advantages of contractual gap and charges additional amount for loss in future revenue services (Wang, 2002) Vendor lock-in Long term contractual agreement (Dibbern & Goles, 2004) Few vendors leads to limited options (Bahli & Rivard, 2003) Lack of trust Uncertainty (Barzel, 1982; Wang, 2002; Adeleye et al., 2004) Business uncertainties Uncertainty (Barzel, 1982; Dibbern & Goles, 2004)

Journal of Global Information Management, 14(3), 39-69, July-September 2006 43 b. Risk as a variance: In finance, risk is calculated as the variance of the distribution of outcomes. c. Risk as expected loss: In some disciplines such as casualty insurance, risk is interpreted as expected loss, which is the product of a loss function and a probability function (Bowers, Gerber, Hickman, Jones, & Nesbit, 1986). RISK FACTORS Many researchers have studied the risk factors that are common in IT outsourcing (Dhar et al., 2004; Earl, 1996; Jurison, 1995; Overby, 2003). We summarize their work on risk factors. We found some studies have addressed many risks factors associated with IT outsourcing. We decided to focus specifically on risk factors that are quite common, important and sensitive to global IT outsourcing, and later validate those using case studies. Of particular interest to us are the effects of risk factors like geographical location, political, cultural, quality standards, legal contracts and intellectual property, etc. The important risk factors for our study are summarized as shown in Table 2. RESEARCH METHOD In order to investigate our research problems, we did a thorough analysis of two large organizations who are involved in outsourcing. We have chosen these two organizations for various reasons. Both organizations are doing IT outsourcing globally for several years. In fact, outsourcing has become a part of their business strategy. Their experience in dealing with offshore vendors coupled with efficient project management expertise helped them coordinate business processes over globally distributed teams. In addition, they had already dealt with multi-cultural teams, diverse geographic and political environment, varying quality, and intellectual property standards in different countries to name a few. Hence we came to the conclusion that these two organizations are good candidates for our research studies. We conducted in-depth interviews with key personnel who were carefully chosen based on their roles, responsibilities, and experience in dealing with outsourcing projects. Although we interviewed a handful of people, they actually represent a large division within their organizations and are actively involved in the outsourcing strategy for their respective organizations. Hence, the data we collected is reliable and truly represent the outsourcing process of their organizations. Our approach is based on positivist case research as proposed in the case research literature (Dube & Pare, 2003) where we focus on qualitative analysis of the results rather than rigorous quantitative and analytical methods. The data have been collected during the year 2003. In order to gain insightful information and perspectives on offshore outsourcing, respondents were given a detailed questionnaire to collect data and outsourcing related information. The participants were assured confidentiality of their personal and organizational information. We analyzed the data by summarizing the interviews and questionnaire filled by each participant from each case. After analyzing the responses from each participant, we again contacted them if necessary for further clarification and explanation. This process of analysis clarified lots of complex issues that they had to deal with and helped us gain further insights in outsourcing. These case studies also reflect the global nature of outsourcing as some of the projects were done offshore. Hence, we tried to capture the global perspective and practices of outsourcing when we developed the cases. In addition, we tried to understand the theoretical perspectives and arguments that each participant put forward in the decision making process. In order to provide deeper insight into our qualitative analysis, we also included some comments from participants. We also did a comparison of the objectives, key benefits, major risk factors, challenges, and best practices for the two cases and explained their implications from Transaction Cost Theory.

44 Journal of Global Information Management, 14(3), 39-69, July-September 2006 Table 2. Risk assessment factors Risk assessment factor People Knowledge (Functional, Technological, Managerial) Cultural Political Financial Quality Standards Measurement Scope, Cost, and Time Estimates Company Specific Risks Legal Contracts and Intellectual Property Security Disaster Recovery Contract Management Description The people risk emerges from the experience level, training, and human resource deployment policies of the vendor. In addition, redeployment of existing IT staff of the customer is also a risk assessment factor (Gilbert, 2001). Functional knowledge is the expertise, understanding, and experiences in the given functional area of the activity. Technological knowledge is associated with the expertise in the areas technology selection, analysis, architecture, design, development, integration, and maintenance support. Managerial knowledge is associated with the project management, risk management, resource management, developing and administrating management processes to carry out the activities. Cultural risks arise from the dominant culture prevalent with the vendor. The attitudes, communication skills, language, selection policies, performance motivation, team spirit, level of cohesiveness, autonomy, participatory decision making, work ethics, management style, customer-orientation, and related organizational behavioral factors that shape the culture. Political risks arise out of trading restrictions imposed by the sovereign, permissible ownership rights, nationalistic aspirations, type of government, and political and economical stability. Financial risks arise out of project accounting standards, cash flow, asset base, and currency stability. Software Capability Maturity Model (CMM) and ISO 9000 compliance are hallmarks of the quality standards. The ability to prepare test plans, and performance standards are seen favorably while assessing the risks due to quality standards. Performance measurement standards, benchmarking, and assurance of the performance are key elements in evaluating measurement risks. Ability to formulate the scope of the project, accurate cost and time estimation poses the risk. Company specific risks are largely due to outsourcer s financial strength, area of core competence, management, relationships and alliances with other major organizations, and (potential) acquisitions and mergers activities. Intellectual property rights and their legal status in the country, brand protection, contractual bindings, and arbitration policies of the outsourcer constitute the risk. Access control, authentication, usage of secure protocols, encryption, and security policies adopted by the outsourcer constitute the risk. Ability to protect software code, and related data, level of replication, redundancy, and back-up and recovery policies are the main factors in deciding the risks due to disasters. Contract management involves formulating contracts, schedule planning, activity planning, sending and accepting deliveries, dispute resolution, and signing off. Inability to properly formulate or execute the contracts constitutes the risk. Implications for Global Outsourcing Globally distributed teams with different skills and experience contribute to risk The level of functional, technological, and managerial knowledge contributes to risk in offshore outsourcing. Managerial knowledge is extremely important in a global context. Country specific cultures can add risk in global outsourcing. Language and work ethics vary from country to country and that may contribute to risk. Political instability is a major concern for global outsourcing as the government rules and regulations may have adverse effect on outsourcing. Accounting standards and variation in currency exchange rate contribute to risk. Quality standards vary from one country to another and contribute to risk. Performance measurement standards vary from country to country which contributes to risk. It is quite difficult to accurately determine scope, cost, and time estimates in global outsourcing. This contributes to risk. Different companies in foreign countries have different management and core competencies. Those contribute to risk. IP standards and law vary from one country to another and contribute to risk. Security is also a major concern in global outsourcing as protection and control of data pose a problem. Loss of control over disaster recovery contribute to risk. Contract management in global outsourcing is a risky business as monitoring the project activities become a challenge.

Journal of Global Information Management, 14(3), 39-69, July-September 2006 45 Table 2. Risk assessment factors (cont.) Risk assessment factor Relationships & Alliances Geographic Location Multi-vendor Arrangements Description Ability to formulate customer-vendor interface at executive and working levels, customer relationship management, and developing long term alliances offers synergy at organizational level. The country, province, and city may be in different time zones, which require working at odd hours for the customer or outsourcer. The communication infrastructure, distance, industrial peace and stability in the region, availability of supporting infrastructure, social-economical-political stability constitutes the risk. Synchronization of development efforts, data format exchange standardizations, complexities due to multi-layer architecture dependencies or non-contagious independent parts constitute the risk with ability to work with multi-vendor arrangements. Implications for Global Outsourcing Inability to manage relationships and alliances constitutes the risk in global outsourcing. Vendor s geographic location poses some risks. Communication infrastructure failure in offshore projects incurs significant loss. In global outsourcing with multivendor arrangements, coordination has to be efficient. Otherwise execution becomes a problem and contributes to risk. CASE STUDY FORMAT In order to understand the objectives, benefits, risks, challenges and best practices of outsourcing, case studies were done for two Global 200 organizations. All the participants joining discussions were involved in outsourcing projects and helped developing the case studies. We conducted a focus group survey of information technology executives and managers from both organizations who were involved in outsourcing information technology projects. Survey participants answered a detailed questionnaire, followed by an interview. The participants were offered choice to mention any other objectives, benefits, best practices, risk assessment factors not listed in the questionnaire. The participants were assured confidentiality of their personal, organizational, and professional role information. The participant also shared their own experience in dealing with outsourcing projects and gave us valuable information about some of the best practices and challenges. Each case has the following four sections: 1. Background: The background section provides a brief description of the organization studied. 2. Introduction: The purpose of the introduction section is to introduce the individuals, from each organization, who participated in the study. These individuals were actively involved in outsourcing decisions of the firms. 3. Outsourcing decision: This section outlines the motivations, challenges, risks, and benefits associated with outsourcing decisions that each of these organizations faced. 4. Case conclusion: The purpose of case study conclusion is to summarize the interview results. It also highlights some deviations in the ratings by the participants of both the firms. Anonymity: Anonymity was deemed necessary to protect the identities of all the participants as well as the name of the organization. Both the organizations are referred to as FIRM- 1 and FIRM-2. As per the requests of the participants, the names of the outsourcing partners are also kept confidential. CASE STUDY: FIRM-1 Background FIRM-1 is a large multi-national organization with more than 20,000 employees and

46 Journal of Global Information Management, 14(3), 39-69, July-September 2006 Table 3. FIRM-1 participants PARTICIPANTS JOB TITLE RESPONSIBILITY Person 1 Senior Manager, IT Responsible for identification of outsourcing opportunities Person 2 E-Business Director Responsible for vendor selection, budget management, and monitoring of delivery of applications to requirements Person 3 Project Manager Vendor management, execution and delivery of the projects 100 offices worldwide. It wants to be the leading provider of semiconductor-based solutions for consumer and communications applications and medical systems. It has annual revenue of approximately US$5-10 billion. It is one of the world s top semiconductor suppliers, with manufacturing facilities and partners in diverse geographic areas. It has 14 manufacturing and assembly sites, 20 design centers, four system labs, and more than 100 offices. The manufacturing facilities are located in the USA, the Far East, and Europe serving customers worldwide. It also participates in its customers businessto-business supply chain extranet. This enables FIRM-1 to get a visibility of demand for the customer s products, which in turn drives FIRM-1 s production plan. FIRM-1 believes that delivering these services and applications depends on the right business model, the right partners, and the right technologies. FIRM-1 is dedicated to semiconductor and related technologies and is customer focused. FIRM-1 provides its partners with scalable, versatile technologies and a worldwide manufacturing base. Introduction Three individuals from FIRM-1 were interviewed. Due to anonymity reasons, their names are not disclosed; they are referred to as Person 1, Person 2, and Person 3. The names of the outsourcing partners are also kept confidential. Outsourcing Decision FIRM-1 s management believes that if a business function is not its core competency, and better value is found externally, it is an ideal candidate for outsourcing. The core competency of FIRM-1 is semiconductor technology, and related R&D activities, which are kept inhouse. Also, it believes that the knowledge of knowing the customers needs and providing those solutions faster to the customers is another key to their success. Many ERP and supply chain functions like manufacturing, fabrication, packaging, warehousing, and shipping and handling are outsourced. For more than 10 years, FIRM-1 has outsourced some of its IT functions, which have changed over time. FIRM-1 is in the process of changing its strategy on IT outsourcing. It is a global organization and has looked at its IT outsourcing globally. It used to have a more distributed outsourcing strategy, but now it is more centralized and from a division standpoint. The top management outlined the IT outsourcing strategy first. It then evaluated the approach not just from the overall organization s standpoint but also from a division standpoint. They picked potential suppliers by type of service, or technology that was required and divided those suppliers by divisions. Divisions then ran pilot projects with these outsourcing vendors for years. The results from these pilot projects were collected, which helped FIRM-1 to decide major outsourcing partners commonly for all divisions. So it took FIRM-1 almost twelve months of activity to get organized for

Journal of Global Information Management, 14(3), 39-69, July-September 2006 47 IT outsourcing. But the strategy was always to keep a part of all these functions, especially controlling them, in-house. When asked about how IT outsourcing decision has helped to reduce the supply chain costs (namely, core costs, non-coordination costs and transactional costs), one manager replied: We are able to treat each application and its development as a variable cost and make very quick decisions based on ROI if we should even build it. Because the development costs are external, we incur no cost unless the initial business case justification (BCJ) process dictates that positive ROI will result. We always build contingency over-run costs into each project as a part of the BCJ process. FIRM-1 has primarily two IT outsourcing vendors and also some niche players. It has divided up the work between the two vendors in order to leverage their strengths. It describes the relationship with the vendors as strategic partners. When asked about their relationship with outsourcing partner, one of the managers told us: It is very positive. Our outsourcing partner has program management personnel in the U.S. and act as members of our team. They understand how our company works and as such, this helps with the software applications that they build for us. The outsourcing partners have their program management personnel on-site (i.e., personnel from the outsourcing partner are located within FIRM-1 s campus) who understand the business processes of FIRM-1. And as such, this helps with the software applications and other services they provide to FIRM-1. It has a dedicated staff to manage the vendor relationship. In the past, FIRM-1 had some failures in terms of managing vendor relationships because of inadequate staffing and poor contractual agreement. After they realized their mistakes, well-defined contracts are framed and signed by both the parties. Also weekly status meetings and monthly progress meetings are held to monitor the performance of the vendors. Based on the responses of the participants, an effort is made to analyze and understand the focus areas like objectives, benefits, risks, and challenges involved in the IT outsourcing decisions in FIRM-1. IT Outsourcing Practices: FIRM-1 keeps the project management functions in-house. It does not outsource project management responsibilities and complete project management control to its vendors. That was mainly a reaction of a bad experience from one of its earlier outsourced projects. However, there are multiple projects in which the roles and responsibilities are generally shared but control of responsibilities of projects itself is never delegated. User acceptance and timeline are always controlled inhouse, and never outsourced. There has been a participative association with vendors in formulating design specifications. FIRM-1 partners with some key vendors to develop design specifications. These vendors are more of key suppliers of software solutions and not pure IT outsourcing partners. It also evaluates their vendors from timeto-time and if there are any value-added services or products that the IT outsourcing vendors have to offer, and if that product or service is beneficial, FIRM-1 definitely takes a close look at it. Another strong driver for FIRM-1 to outsource some portions of its IT is to focus on its core competency. In order to rapidly deploy their breakthrough projects, it takes its best and brightest resources to put on these projects. Therefore, these resources cannot do more repetitive and stable jobs. FIRM-1 tries to free up these core competent people to focus on its core processes, and to improve its competitive advantage. FIRM-1 tries to outsource its non-critical jobs to vendors. With the help of pilot projects, FIRM-1 has identified couple of IT competencies, which it has in-house. The demand for these competencies is quite variable.

48 Journal of Global Information Management, 14(3), 39-69, July-September 2006 Figure 1. Histogram for objectives for IT outsourcing (FIRM-1) 10 Ratings (0-10) 8 6 4 2 Person 1 Person 2 Person 3 0 Strategic goals Lower Costs Core activities Customer Satisfaction Competitive advantage Quality & reliability Professional services New technology as an advantage Legacy systems Capital expenditure avoidance Objectives (Alw ays = 10, Very often = 8, Often = 6, Sometimes = 4, Rarely = 2, Never = 0) State-of-the-art technology So instead of maintaining it in-house, FIRM-1 decided to acquire those competencies through outsourcing partners. Moreover, these jobs are non-critical and are not related to FIRM-1 s core business, its business creation initiatives or its ERP and supply chain management initiatives. Objectives: For FIRM-1, cost reduction, focus on core activities, and professional services are the main objectives for outsourcing its IT to external vendor. Building competitive advantage, quality and reliability, access to state-of-the-art technology, and customer satisfaction are also some important objectives for IT outsourcing in FIRM-1. Knowledge about consumers needs and providing solutions for those needs are very important to FIRM-1. So participants said that increased flexibility to meet the changing demands and market environment, and reduced time to market are other key objectives for outsourcing IT activities to their vendors. Based on the participants responses a histogram is plotted, which is shown in Figure 1. While two respondents think that new technology can be an advantage, one respondent thinks that unproven/untested new technology can pose a risk to outsourcing and hence disagrees with others. Benefits: Participants from FIRM-1 emphasized that the main benefits achieved by outsourcing IT are reduction in costs, and optimal allocation and utilization of internal resources. FIRM-1 outsourced its IT function to low-cost and competent vendors in different countries, thus saving money. By outsourcing some functions of its IT, the management could identify and allocate its key resources, and utilize them efficiently to build a competitive advantage. Reduced time to market/reduced delays, improved flexibility to respond to the changing demand and business environment, predictable outcome, and higher degree of success are some other benefits that FIRM-1 realized by IT outsourcing projects. Quality and reliability was also one of the benefits achieved by FIRM-1. Each of the benefits was rated on a scale of 0-10. Based on the participants responses a histogram is plotted, which is shown in Figure 2.

Journal of Global Information Management, 14(3), 39-69, July-September 2006 49 Figure 2. Histogram for benefits of IT outsourcing (FIRM-1) Ratings (0-10) Ratings (0-10) 12 10 8 6 4 2 0 State-of-the-art technology Flexibility Lower costs Predictable outcome Reduced delays Higher degree of success Lower failures Quality & reliability Lower risk profiles Better management control Reduced complexity Benefits (Always = 10, Very often = 8, O ften = 6, Sometimes = 4, Rarely = 2, Never = 0) Optimal resource allocation Identify business opportunities Person 1 Person 2 Person 3 Risk Factors: Knowledge being the core competency for FIRM-1, is the main risk factor for the firm. A careful planning of what knowledge to keep in-house and what to outsource is required. FIRM-1 wants to protect the core knowledge because it is afraid that outsourcing of core knowledge will make them very much dependant on the vendors. This will make the vendors in an advantageous position in the outsourcing deal. Formulating scope and deciding the budget and schedule estimates is another critical risk factor. In the past FIRM-1 missed some schedule and the cost exceeded the budget. Also the vendor did not provide the optimal service, because the scope was not clear. FIRM- 1 learnt from its failures. And because ultimately it is FIRM-1 who is answerable to the consumers, a clear understanding of the requirements, finalizing the scope, and agreement of both the parties are very important to FIRM-1 along with budget and schedule. Apart from these, quality standards, financial stability of the vendor, its disaster recovery plans, and security are some of the important risk factors to FIRM-1. When asked what risks their customers and suppliers may have faced from their decision of outsourcing, one of the managers told us: We have had very difficult and costly outsourcing. We outsourced not only applications development and management of applications but also outsourced most of the staff. We outsourced too much of our core knowledge. And also under estimated what it takes to manage vendor relationship at that price, and we didn t manage it well. As a result it became very advantageous to suppliers and disadvantages to our customers. Very high cost and high stakes are involved here. People, contract management, and performance measurement are some other important risk factors for FIRM-1. Legal contract and intellectual property protection is another risk factor for FIRM-1. Though FIRM-1 has a very efficient legal department to take care of the penalties and other legal issues of the contract, it believes that brand protection and intellectual property rights protection are key risk factors. Figure 3 shows a histogram based on the responses of FIRM-1 participants.

50 Journal of Global Information Management, 14(3), 39-69, July-September 2006 Figure 3. Histogram for risk factors of IT outsourcing IT (FIRM-1) Ratings (0-10) (0-10) 12 10 8 6 4 2 0 People Knowledge Cultural Political Financial Quality Standards Measurement Scope, cost, and schedule Company specific risks Legal and IP issues Security Disaster Recovery Contract Management Relationship & Alliances Geographic Location Multi-vendor arrangements Risk Factor (Always = 10, Very Often = 8, Often = 6, Sometimes = 4, Rarely = 2, Never = 0) Person 1 Person 2 Person 3 Challenges: The main challenges for FIRM-1 in outsourcing IT projects are: (a) deciding what jobs to keep in-house and what to outsource, (b) ongoing vendor relationship management, and (c) setting up a governance model. Selecting the right vendor is very challenging for FIRM-1. But since it has a cross divisional strategy, it has the option of partnering with alternative vendors. And that makes the ongoing management of vendor relationship as one of the biggest challenges. Another challenge for FIRM-1 is the continuous commitment to the spirit of partnership. Cultural barriers and designing a contract do not pose a challenge for FIRM-1. Since FIRM-1 has a global presence, and has operations in many countries world wide, one of its strategies is to provide training, from time-totime, to all its employees to deal with various cultures. Also designing a contract, especially the legal issues are well taken care by its legal department. Figure 4 shows a histogram based on the responses of FIRM-1 participants. Best Practices: One of top best practices for FIRM-1 is stakeholders buy-in. This has helped FIRM-1 to deal with internal resistance and to carry out change management effectively. It also holds frequent informal meetings to review the progress of the projects. FIRM-1 has the policy of First Things First. It prioritizes the action items as per their priority. Other practices like empowerment and formation of steering committees and joint review boards are also important in FIRM-1 s opinion and it practices them on a regular basis. Based on the responses of FIRM-1 participants, a histogram, as shown in Figure 5, was plotted. Case Conclusion By outsourcing some portion of IT, FIRM- 1 is able to efficiently manage its information systems. Some other measures that FIRM-1 has taken to tightly integrate its supply chain management with information systems are partnering with multiple vendors, penalties for non-performance, and well defined and dedicated management roles.

Journal of Global Information Management, 14(3), 39-69, July-September 2006 51 Figure 4. Histogram for challenges of IT outsourcing (FIRM-1) Ratings (0-3) Ratings (0-3) 4 3 2 1 0 What to outsource Vendor Selection Cultural barriers Contract Design Set up governance Vendor management Commitment Challenges (Critical = 3, Moderate = 2, Can deal with = 1, Not important / NA = 0) Person 1 Person 2 Person 3 Figure 5. Histogram for best practices in IT outsourcing (FIRM-1) Ratings (0-3) Ratings (0-3) 4 3 2 1 0 Empowerment/Escalation Peer Relationships Informal Communications Establish a Special Entity Additional Managers Prioritize Action Items Strategic Issues Review Steering Committees Stakeholder Buy-in Corp. Communications Best Practices (High Importance = 3, Medium importance = 2, Low importance = 1, Not important = 0) Person 1 Person 2 Person 3 The management has explained the firm s strategy to all its employees, and it has tied this strategy to the current business environment. The employees are trained in newer technology, and from time-to-time they are also sent to such educational seminars and training programs. From an organizational standpoint, most of the organizations go in search of low-cost and competent services. And that s what FIRM- 1 has been doing. FIRM-1 believes that there will be 50% cost reduction if all but management and control are outsourced; 25% if only part of the activity is outsourced. From the analysis, it is observed that cost reduction along with competent services is the main driving factor behind IT outsourcing decision. Costs are mainly related to development of a service or an IT application. By lowering costs, FIRM-1 was able to save money in a stringent budget situation, which is a driving factor for outsourcing. Focus on core activities; professional services, and reduced time to market are some other motivations and benefits.

52 Journal of Global Information Management, 14(3), 39-69, July-September 2006 Cost and loss of critical skills are the most important risks associated with IT outsourcing decision for FIRM-1. Deciding what jobs to outsource, ongoing vendor relationship management, and continuous commitment to the spirit of partnership pose challenges for FIRM- 1 in making IT outsourcing decisions. Apart from these, some other observations are noted in each of the focus areas. The participants said that it is a good strategy to outsource legacy systems, and that has been the trend for most of the organizations. FIRM- 1 did outsource legacy systems in the past but are not doing it currently as it experienced some unsatisfactory outcomes in the past. So currently it is in the process of removing a bunch of legacy systems and do not want to outsource them at the end of their life cycle. FIRM-1 believes that letting an external vendor to replace the internal staff or anything in-house is definitely very complex. In the past, it had some failures. It had to continuously coordinate and monitor the outsourcing partner, which was not simple. So for FIRM-1 reduced complexity is not a benefit at all. In the risk category, Geographical location is not a big risk factor for FIRM-1 to outsource their projects. Currently the trend is to move to Asia-Pacific region, especially India, for outsourcing jobs. This is mainly because low cost and competent service. But participants were of the opinion that in another five-seven years China may also become one of the choices; it may also offer similar services. So the trend would again change. Hence, FIRM-1 does not have any preference for any geographical location. It is also worth mentioning that FIRM-1 does not worry about contractual amendments costs as it is well taken care of by its very efficient legal department. It has never experienced loss due to outsourcer s opportunism because of the type of business it is in. It believes such risks are mostly applicable to smaller organizations, startups, and software organizations. Since FIRM-1 does not market its software, so does not have this risk. They did face the risk of lack of trust but as soon as they realized that they got rid of that outsourcing vendor. The participants stated if the partnering relationship is not winwin or satisfactory to both the parties, FIRM- 1 does not plan to continue with the relationship. Hence, FIRM-1 evaluates its vendors quite meticulously because primarily if there is no trust between them, FIRM-1 does not do business with those vendors. To summarize, high competency and low cost, non-core business functions are the key drivers of the outsourcing deals. Applying Transaction Cost Theory in our analysis, it is apparent that reducing transaction costs played an important role in the decision making process. Also, threat from opportunism and uncertainty is a risk for outsourcing. CASE STUDY: FIRM-2 Background FIRM-2 is a major, multi-national networking organization with annual revenues over US$20 billion. It provides the broadest line of networking solutions to most of the corporate, education, and government centers. Their hardware, software, and service offerings are used to create Internet solutions that allow individuals and enterprises to increase productivity, improve customer satisfaction, and strengthen competitive advantage. It conducts most of its business over the Internet, and is recognized as the leader in this area. FIRM-2 outsource much of its production. Customers visit the Web site to configure, price, route and place orders directly to FIRM- 2. More than half of the orders are directly transmitted to the suppliers. Once the product is manufactured, it is shipped directly to the customer. As a result the order-to delivery cycle time is reduced from approximately eight weeks to less than three weeks. Moreover, this helped FIRM-2 and its suppliers to manufacture based on actual orders and not on projection, lowering inventory costs for both FIRM-2 and its suppliers, while making customers happy with the speed of fulfillment of the orders. Additionally, 85% of customer queries are handled through FIRM-2 s Web site. It has established a business-to-business supply chain

Journal of Global Information Management, 14(3), 39-69, July-September 2006 53 Table 4. FIRM-2 participants PARTICIPANTS JOB TITLE / ROLE RESPONSIBILITY Person 4 Lower Management Manage day-to-day IT activities with the regression facility at the outsourcing partner s facility in India; ensure that process is followed and reset / redesign process, if needed. Person 5 IT Manager Responsible for managing team of IT professionals (Middle Management) Person 6 Manager Part of the group responsible for setting up the relationship with offshore outsourcing organizations Person 7 Senior Manager Responsible for outsourcing Order-to-cash processes and systems, and for making outsourcing decisions. Person 8 Senior Manager Responsible for defining business requirements, and prioritizing the outsourced tasks. extranet for its manufacturers and suppliers. This online exchange is used to purchase supplies, make reports, and submit forecast and inventory information. With the help of this common platform, it has been possible for both FIRM-2 and its suppliers to reduce inventories by 45%. FIRM-2 uses Internet extensively in every department of the organization. It also makes extensive use of intranet for its employees. Its employees use it to enroll in organizational benefits, and file expenses. More than 50% of technical training is provided online, saving the organization employee time and travel money while enabling employees to receive more training. Even peer reviews, collection of market information, and monitoring sales are all done online. It has also established a business-to-business supply chain extranet for its manufacturing partners and suppliers. With their Internet-based financial applications, they are able to continuously monitor their sales data and are able to close their books within a short period of time. Introduction Five individuals, from various divisions at FIRM-2, were interviewed. Table 4 shows their role and responsibilities. FIRM-2 has outsourced its IT functions for the last five years. It has outsourced only portions of IT such as design, development, bug fixes, enhancements, and customer support. FIRM-2 first identified those activities, which could be sent outside to finish faster. The core activities were kept in-house and the context activities were given out. Overall for the FIRM-2, there is a central program office, which manages the relationship with the vendors and all the rates are negotiated centrally. FIRM-2 outsource its IT activities with five outsourcing vendors. It describes its relation with the vendors as very collaborative, focused on the success of business client. During the outsourcing operations, the IT managers met with Offshore Development Center (ODC) managers on regular basis. On site account managers ensure that critical issues are handled appropriately and provide oversight of entire operation. Outsourcing Decision FIRM-2 is recognized as an innovator in conducting business over the Internet. It says that partnership is one of the pillars for the growth of the organization and such strategic partnerships have helped and contributed significantly to the customer s, partner s and FIRM-2 s bottom line. These strategic partnerships help FIRM-2 to focus on its core activities, and have helped FIRM-2 to reduce time to market. With these strategic alliances, it is pos-