Costs, Transaction-Specific Investments and Vendor Dominance of the Marketplace: The Economics of IS Outsourcing

Abstract

This paper studies determinants of information systems (IS) outsourcing. It argues that a focus on comparative economic theories and models can improve our ability to explain outsourcing within the larger context of organizational strategy and environment. Specifically, the research constructs of production cost, transaction cost, financial slack, and firm size are examined to understand what influences the outsourcing decision. To empirically test these relationships, a field study gathering information from senior IT managers in 243 U S. banks was conducted. Financial indices from the archives of the Federal Reserve Bank were a second important source of data. Results of the study showed that IS outsourcing in banks were influenced by production economies, transaction economies, and firm size. The paper has important implications for research and practice. For researchers, the findings suggest that some financial criteria are key factors in outsourcing decisions, but not all. Recapitalizing the IT investment, for example, is a short term strategy that managers may not and, probably, should not be adopting. For practitioners, the findings suggest that sourcing strategies need to weigh both direct and indirect costs when hiring systems integrators. Small firms need to consider whether they have sufficient economies of scale to justify internal provisioning.