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A RESEARCH PAPER TO ASSESS THE INFLUENCE OF BUISNESS STRATEGY AND

FINANCIAL CONSIDERATION ON OUTSOURCING POLICY AND ITS IMPACT ON


PRODUCTIVITY

Prepared BY: NITIN KUMAR


MMS::5Yrs.(7TH SEMESTER)
IM-98-38
Introduction
With nearly one-half of U.S. corporate capital being invested in information technology (Keen
1991) and IS expenditures representing the third largest corporate expense (Benko 1992), the IS
function has become the prime target for outsourcing.so here it has been looked upon in the context
of the Indian companies for which data has been collected from publication from business today
magazine last year issue as well as from computer express and last but not the least from computer
world website. The outsourcing of IS is so popular among communications companies, computer
vendors, and semiconductor firms that an industry report notes that the "computerless computer
company will soon dominate the industry" (Rappaport and Halevi 1991). Several organizations are
considering outsourcing as one of the key options for improving information systems performance
(Due 1992). Similar developments suggest increased relevance of IS outsourcing and outsourcing
policies to IS research as well as IS practice.
IS outsourcing policies define the criteria that organizations utilize to decide upon the scope [of
specific capabilities and degree of reliance for each capability] of their dependence upon external
sources for meeting their IS needs. There is an ongoing debate on the pros and cons of the
information systems outsourcing policies being pursued by different organizations and the rationale
for those policies (Bettis, Bradley & Hamel 1992, Davis 1992, Due 1992, Lacity and Hirschheim
1993a, Sharp 1993). Among several factors responsible for firms' increased drive toward
outsourcing of IS, financial considerations and business strategy have been discussed as the two
major reasons (Hopper 1990, Huber 1993, Quinn and Hilmer 1994, Sue 1992, Thames 1992). Most
controversy on outsourcing of the IS functions has revolved around the issue of increasing the
productivity of the information systems (Brynjolfsson 1993, Due 1994, King 1994). In this context,
the study of the interrelationships between IS outsourcing policy, the business and financial
strategy considerations and IS productivity, is increasingly relevant for providing a more balanced
perspective to the ongoing debate.
The conceptual framework proposed here is expected to facilitate the two primary Objectives of
this study: (i) to assess the influence of business strategy and financial conditions on IS
outsourcing policy, (ii) to evaluate the relative importance of financial considerations and IS
outsourcing policy as determinants of IS productivity.
This following section provides a detailed perspective of the IS outsourcing policy decisions with
specific focus on the financial considerations and business strategy. Section 1 delineates the
conceptual framework used for the study, the structural form of the model and the
operationalization of the constructs used for the study. Section 2 discusses the factor analysis
results used for determining the factors underlying the variables used in the study. An overview of
the various regression analyses used for determining the structural equation parameters and the
solutions of those equations is provided in section 3. The concluding section includes a discussion
regarding the operationalization of the study, an analysis of the findings and their limitations, and
implications for future IS research and practice.

Characteristics of I/S Outsourcing Decisions


Encouraged by the projections of phenomenal cost savings, many Fortune 500 firms are jumping
on to the "outsourcing bandwagon" (Lacity and Hirschheim 1993b). A survey of
LEADERS(CEO’S) shows that 42% of communication firms, 40% of computer manufacturers, and
37% of semiconductor companies rely on outsourcing from foreign firms. These same CEOs expect
the figures on outsourcing to exceed 50% before the mid-2005 Yet, despite its growth, outsourcing
is frequently perceived to be poorly controlled, high in cost, and a drain on quality and service
performance
Cost savings has often been cited as the main driver for the IS outsourcing decision (Due 1992, Loh
and Venkatraman 1992a).On the other hand, the short-term focus on financial performance without
consideration of the strategic implications has also been criticized (Davis 1992). Another driving
force for outsourcing is management's perception that by surrendering control of its IS to an
external supplier it can better focus on its core business (Grover and Teng 1993, Huber 1993,
Quinn et al. 1990). A third motivating factor relates to the perception of the IS in the organization --
companies consider outsourcing when the internal IS function is perceived to be inefficient,
ineffective or technically incompetent (Lacity and Hirschheim 1993a). Based on their case studies,
Lacity and Hirschheim (1993a, 1993b) suggest that the outsourcing decision may be a result of
rational consideration or it may be a product of organizational politics, conflicts and compromises.
They conclude that organizations engage in outsourcing evaluations because outsourcing is
inherently about creating a perception concerning the efficiency (and perhaps effectiveness) of the
internal IS function.
Some critics (Due 1992, Lacity and Hirschheim 1993b) argue that IS outsourcing can result in loss
of control over IS/IT assets, threat of opportunism [from the supplier], the loss of IS expertise and
corporate memory, and a decline in the morale and performance of the remaining employees. They
also suggest that the anticipated cost savings might also be achieved internally, i.e., without
sourcing externally (Benko 1992, Carlyle 1990, Davis 1992, Due 1992, Lacity and Hirschheim
1993a, Sharp 1993). Evidently, most controversy regarding IS outsourcing remains around the
issue of balance between strategic implications and financial returns.
Role of Financial Considerations in IS Outsourcing Decisions
Historically, many firms have made sourcing decisions based primarily on anticipated cost savings
(Grover and Teng 1993, Huber 1993, Venkatesan 1992), with insufficient regard for strategic or
technological issues (Welch and Nayak 1992). Many firms assert that they are justified in
outsourcing their 'commodity' activities and retaining their 'core competencies' in-house. Are these
organizations really retaining their core competencies by outsourcing their IS/IT functions?
Considering the very fact that these firms may also be outsourcing their capacity to learn and
coordinate technologies within the business (Prahlad and Hamel 1990) and giving up the
opportunity to build "core learning competencies" (Senge 1990), the value of IS outsourcing is
questionable. In his criticism of the comparison of the IS function with "catering" services, Lowell
(1992) argues that the "essentialness" of the processes, updates and storage that are performed on
computer systems and that form an essential element of most products sold by financial companies
distinguishes them from "buying statement paper." For instance, the products sold by all financial
services companies consist, in most part, of transactions processed and accounts updated and
maintained.
Information Technology Outsourcing and Business Strategy
The role of [information] technology in achieving competitive advantage has been described as that
of an enabler of several business strategies such as changing industry structure, decreasing buyer or
supplier power, raising entry barriers, and creating new products and markets (Porter 1985). The
role of IT has also been well-recognized in the exploitation of structural differences among firms
(Clemons and Row 1987), in supporting economic reorganization (Clemons and Row 1989) and in
providing "a corporation an edge over its competitors" (Cash and Konsynski 1985). Jarvenpaa and
Ives (1993) have elaborated on the role of IS in the coordination of global operations of the
multinational firm. Citing several reasons for considering technology strategically, Kantrow (1980)
states that: "Technological decisions are of fundamental importance to business and therefore, must
be made in the fullest context of each company's strategic thinking."
When technology is not considered in developing the business strategy, the results are missed
opportunities that could have contributed to the achievement of the organization's goals (Frohman
1985). In contrast to the earlier emphasis on the strategic [and competitive] role of IS in
organizations (Blanton 1992, Boynton 1993, Clemons 1990, McFarlan 1984, Porter and Millar
1985, Raghunathan and King 1988, Tavakolian 1989), increasingly, companies are viewing IS as a
utility (Hopper 1990) that can be "rented" from an external supplier (Bettis et al. 1992). A critical
question that has remained unanswered is if information and IS can be treated as mutually
independent entities. In other words, can organizations retain their control over information even
when they give up their control over the systems and the IS function? Until a definitive answer to
this question is discovered, organizations need to consider if the advantages generally associated
with outsourcing decision are being compromised by a potential loss of intellectual capital invested
in IS or long-term implications for business strategy.
The Need for a Framework for the Outsourcing Decisions
Although various authors (e.g. Putrus 1992) have offered diverse opinions on the outsourcing issue,
theoretical work on outsourcing in general, and IS outsourcing in particular, is sparse. Few
managers have a basis for evaluating outsourcing as a management tool (Jacobs 1994), especially
for determining if outsourcing decisions need to be guided by the overall business strategy or
primarily by financial considerations.
It has been demonstrated in several industries -- information intensive and not so information
intensive -- that outsourcing IS/IT may lead to the loss of a capability that could potentially be a
key success factor (King, Grover and Hufnagel 1989). Indeed, this has been proposed as a planned
strategy of "hollowing" (Jonas 1986) -- a term that was initially used to describe a state of
unplanned industrial decline (Bettis et al. 1992). In most cases of outsourcing, the adverse or
unforeseen results accompanying outsourcing of IS have been due to the mismatch between the
antecedent [i.e., business strategy or financial considerations], the mediating variable [IS
outsourcing policy] and the consequent [IS productivity]. Therefore, a framework that analyzes
these relationships together has considerable practical appeal for both researchers and managers of
IS.
This study attempts to fill the existing void by proposing an integrative conceptual framework for
determining: (a) the relative importance of business strategy and financial considerations in
determining the IS outsourcing policy, (b) the relative importance of financial considerations and
company's outsourcing policies in driving IS productivity. The framework suggested in this study,
while consistent with the 'new' models of the IS organizations such as the "emergent IS
organization" of Venkatraman and Loh (1994), provides a more general perspective that also has
significance beyond the IS context. In other words, this framework can be extended to apply to
other organizational outsourcing decisions which may involve processes or functions other than IS.
Generally outsourcing refers to the dependence of the firm's Information Systems (IS) department
upon external organizations, but for the purpose of this study we are primarily interested in the
dependence of the IS department upon external sources: both inside as well as outside the
organization. This generalization is based on the premise that determination of the capabilities of IS
i.e., evaluation of its performance is better reflected in its dependence upon any external sources.
1. Conceptual Framework for the Proposed Model
This conceptual framework proposed here has two primary motives: (i) to assess the influence of
business strategy and financial conditions on IS outsourcing policy, (ii) to evaluate the relative
importance of financial considerations and IS outsourcing policy as determinants of IS productivity. In
the following discussion, objective (i) is characterized by an equation of the form:
OP = f(B,F)…………………………….(1)
Where the symbols denote vectors with components representing IS Outsourcing Policies (OP),
Business Strategy (B), Financial Conditions (F), and f denotes "function of." The other objective (ii) will
be studied with an equation of the form:
ISP = g(F,OP)…………………………..(2)
Where the components of ISP represent IS productivity, and those of F and OP are as described in
Table 1, and g denotes "function of." These two objectives are combined in a model depicted by means
of the arrow diagram in Fig. 1.

Specifically, while IS productivity is influenced by the financial considerations and the IS outsourcing
policy, the IS outsourcing policy is in turn influenced by the financial conditions and business strategy.
This is the primary hypothesis that combines the two objectives within a single conceptual framework.
In agreement with the preceding discussion, the framework does not include any direct influence of
business strategy on IS productivity.
Rationale for the Proposed Model
(1) The financial considerations and the company's business strategy [with respect to the IS function] are
the two primary drivers of IS outsourcing decisions. Since financial conditions influence the allocation
of capital among various functions, increased focus on them would result in outsourcing decisions that
are primarily aimed at cutting costs and reducing IT investments. On the other hand, greater focus on
business strategy would result in outsourcing decisions based primarily on the strategic significance of
the various IS activities. This does not necessarily imply that business strategy would never prescribe
outsourcing. Nor does it imply that the decision resulting from financial considerations and business
strategy will always be mutually exclusive.
(2) Financial considerations and the company's outsourcing policies are the two key drivers of IS
productivity. IS productivity is driven by the investments in information systems and information
technology. Of course, effective implementation and management of IT is assumed in this case.
Alternatively, IS productivity may be influenced by sourcing out some of the IS activities to external
vendors [with or without] the primary objective of cutting costs or saving further investments in IT.
Outsourcing may also be done to improve performance by seeking external help in case of little in-house
expertise, or else it may be done for the purpose of upgrading in-house expertise to newer technologies.
Therefore, IS productivity could be influenced by financial considerations as well as by IS outsourcing
policy, which may or may not be interactive.
The various endogenous and exogenous variables and the corresponding indices used to represent them
in the conceptual model are listed in Table 1. The following discussion relates to the various causal
relationships depicted in table 1.
IS Outsourcing Policy
Greater the % IS budget spent outside IS department, lesser the reliance on internal IS department and
greater the reliance on external sources. The expectation from outsourcing is to improve IS performance.
Financial Considerations
Business cost structure Firms try to produce their output below the average cost and are constantly under
pressure in a competitive marketplace to reduce the relative cost of business operations.
Financial leverage The need to reduce reliance on debt financing has been a key factor in the IT
outsourcing decision.
Business performance Under conditions of poor business performance, firms seek to streamline their
operations, including selling off or redeploying assets.
IT cost structure Greater expenditure on IT may induce the organization to outsource the IS function to
benefit from the vendor's economies of scale.
IT Performance Greater return on the IT investment may imply better performance of IS. It may also
discourage the organization from considering outsourcing options.
Business Strategy
Relative Importance of IS Greater percentage of budget allocated to IS, greater yearly increase in IS
budget or greater percentage of employees in IS function -- may imply greater relative importance of IS
in the firm.
Strategic Position of IS within firm Firms in which IS function is considered to be of relatively greater
strategic significance generally have the CIO reporting directly to the chief executive or president, while
firms that value financial considerations over strategic considerations may have the CIO reporting to the
financial executive.
Table 1. Variables Used in this Study and their Units of Measurement
_______________________________________________________________________

Note: In the following table, the Variables are represented by the


INDICES listed under them.
Subcategories of indices presented under some variables are based on
theory and intuition.

ENDOGENOUS VARIABLES
IS Outsourcing Policy (OP)
Criteria used by organizations to decide upon the scope of their
dependence upon outside IS vendors
for meeting their needs.
ISOUT % IS Budget Spent Outside IS Department

IS Productivity (ISP)
Return from investments in IS.
IPI (Information Productivity Index)

EXOGENOUS VARIABLES

Financial Considerations (F)


Financial conditions of the company that may affect allocation of capital
and cost-cutting measures for different functions.

Business cost structure


CSSA (Cost of Goods Sold + Selling, General & Administrative Expenses)/Sales
CSTA (Cost of Goods Sold + Selling, General & Administrative Expenses)/Total
Assets

Financial leverage
LDSE Long-term Debt/Shareholders' Equity
TLSE Total Liabilities/Shareholders' Equity Business performance
REOA Return on Assets
EAPS Earnings Per Share ($)

Technology cost structure


ITGP IT Expenditure/Gross Plant, Property & Equipment
ITNP IT Expenditure/Net Plant, Property & Equipment Return on Technology
NIIT Net Income/IT Expenditure
SAIT Sales/IT Expenditure

Business Strategy (B)


Strategic significance of the IS function in the company.

Relative Importance of IS
ISBDGT IS Budget as % of Revenue
BDGTCHG Growth in IS Budget (% over last 5 years)
ISPEMP Total Number of IS Staff/Total Number of
Employees

Strategic Position of IS within firm


TOCEO Categorical variable to indicate if CIO reports
directly to CEO or president of the firm.

TOCFO Categorical variable to indicate if CIO reports to a finance


Executive (to determine bias towards Financial Considerations)
____________________________________________________________________________________

1 A. Structural Form of the Model


The model obtained directly from theory is said to represent a structural model. For this study the
structural model is based upon the equations (1) and (2) defined before.
OP = A0 + A1*F + A2*B (3a)
ISP = B0 + B1*F + B2*OP (3b)
Where,
OP = Outsourcing Policy (Endogenous Explanatory)
ISP = Information Systems Performance (Endogenous)
F = Financial Considerations (Exogenous)
B = Business Strategy (Exogenous)
Ai = Parameters that are assumed to have specific values
Bi = Parameters that are assumed to have specific values.
The two equations of the model satisfy the condition of identifiability. The reduced form of the model is
presented below.
Reduced Form of the Model
The reduced form expresses each endogenous variable only as a function of the exogenous variables in
the model.
OP = a0 + a1*F + a2*B (4a)
ISP = b0 + b1*F + b2*B (4b)
1 B. Units of Observation
The units of analyses are the 100 firms that were described as "the 100 most effective users of
information technology" in the Computerworld Premier 100 of September 19, 2001. This sample is
suitable for this study because our purpose is to analyze the relative significance of financial and
strategic considerations in determining the outsourcing policy and further analyzing the impact of these
policies upon IS productivity.
1 C. Description of Data and Sources of Data
The index representing IS outsourcing policy (OP) is "Percent IS Budget Spent Outside IS Department"
(ISOUT), and is taken form the table of Premier 100 (Computerworld 2001). The assumption is that a
greater percentage of this figure implies lesser reliance on internal IS department and greater reliance on
external sources.
The index representing IS productivity (ISP) is the "Information Productivity Index" presented in the
table of Premier 100 (Computerworld 2001). IPI reflects the return on management of information
systems and information technology. A higher IPI implies superior productivity of IS. The use of this
index is especially interesting considering that it was suggested to be a better indicator of IS productivity
than traditional measures such as those based on organizational financial performance (Strassmann
1990,1994). The computation of this index is given below.
IPI = [(Profit before taxes-provision for income taxes)-cost of capital]/[Selling, general &
administrative expense]
The indices for Financial Considerations (F) to be used for the model are CSSA, CSTA, LDSE, TLSE,
REOA, EAPS, ITGP, ITNP, NIIT and SAIT. As shown in Table 1 these measures are representative of
the Financial Considerations subcategories -- business cost structure, financial leverage, business
performance, technology cost structure and return on technology. These were computed from financial
figures of the companies and the computation was based on an earlier study on IS outsourcing (Loh
and Venkatraman 1992a). The data for these computations was obtained from electronic database
Compact Disclosure and the companies' annual reports for 2000-2001. The values of indices for
Business Strategy (B), namely ISBDGT, BDGTCHG, ISPEMP, TOCEO and TOCFO, were derived
from the data listed in the table of Premier 100 (Computerworld 2001).

2. Determination of Indices to Be Used in the Analysis


For the operationalization of the model in equations (1) and (2) it is necessary to explicitly specify
the indicators to be used to quantify its components. The methods of factor analysis can be used to
identify the underlying dimensions, called factors, of the variables and to compute weighted
averages of appropriate observed indicators to construct indices that represent those dimensions.
These constructed indices are called factor scores. They not only represent the basic dimensions of
the observed data, but also have the advantage of being uncorrelated even if it is not so for the
original indicators. As a consequence, they decrease the risk of multicollinearity in regression
analysis that is later used to test hypotheses about the determinants of IS outsourcing policies and
IS productivity.
Since several indices are used to represent the exogenous variables F and B, we need to do factor
analyses for each of them to determine if they have one or several dimensions. Table 2 presents the
summary of data and indices obtained by the factor analysis for determining the underlying indices
of Financial Considerations and Business Strategy.
In table 2, reference A represents the factor analysis done for the Financial Considerations and
reference B represents the factor analysis for the Business Strategy variables.
Table 2. Data and Indices Obtained by Factor Analysis
___________________________________________________________
Factor Analyses
-----------------------------------------------------------
Data Reference Index
___________________________________________________________
Financial Considerations(F)
Return on Technology A Performance index
NIIT
SAIT
Technology cost structure
ITGP
ITNP
LDSE
EAPS A Long-term index
Business cost structure A Business cost index
CSSA
CSTA
REOA
TLSE A Short-term index
Business Strategy(B)
Strategic Position of IS B Position index
TOCEO
TOCFO
Relative Importance of IS B Competitive index
ISBDGT
BDGTCHG
ISPEMP
Short-term effect of IT investments on financial performance.
2 B. Indicators of Business Strategy
The factor analysis (reference B listed in table 2) of the five business strategy indicators supports
their categorization into the two classes that were based on intuition. The first factor includes the
two variables constituting the strategic position of IS within the firm (TOCEO and TOCFO). The
second factor links the three indicators dealing with the relative importance of IS to signify the
competitive thrust of the IS resource.

3. Two Stage Least Squares Method for Determining the Parameters of the
Structural Equations
Two stage least squares method was used to determine the parameters of the structural equations.
Since, ISOUT is the only endogenous explanatory variable in the model and is itself independent of
any other endogenous variable, the parameters of the reduced equation for ISOUT would also be
valid in case of its structural equation. Nevertheless, the parameters of the other endogenous (non-
explanatory) variable, specifically IPI, would need to be determined using the estimated values of
ISOUT. First, an ordinary stepwise regression was done on the equations of the reduced model.
Then the parameters from this regression were used to derive the estimated values of the
endogenous explanatory variable (ISOUT index of the OP variable). The estimated values of the
endogenous explanatory variable were used for the next stepwise regression to determine the
parameters of the structural equation for the other endogenous (non-explanatory) variable.
3 A. Determinants of Information Systems Outsourcing Policy
The objective of this section is to analyze the relative influence of financial considerations and
business strategy on IS outsourcing policies, that is, to analyze equation 1. For this purpose, IS
outsourcing policy will be represented by the indicator of percentage of IS budget spent outside IS
department (ISOUT). The explanatory variables are divided into two groups. First, financial
considerations are represented by the four factors -- performance index, long-term index, business
cost index, short-term index -- obtained from factor analysis A. Second, business strategy is
represented by the two factors -- position index and competitive index -- obtained from factor
analysis B.
The standard regression methods were chosen to do the analyses because the variables were
essentially indices and hence continuous in nature. Stepwise regression was used to select the
indicators of financial considerations and business strategy that were to be included in the
equations. Only the indicators that maximize the explained variance of the information systems
outsourcing policy variable (ISOUT) and have at least a .05 significance level appear in the results
in Table 3. As mentioned before, the parameters obtained for this reduced equation of ISOUT will
also be valid in case of the structural equation of ISOUT
Table 3: Determinants of IS Outsourcing (ISOUT)
___________________________________________________________
Explained Variable
___________________________________________________________
Explanatory Variables a,b,c % IS Budget Spent Outside IS Department
___________________________________________________________
R-Square .1421
F valuec [2,72]
5.96
Sig F .004
Constant 138.93
A. Financial Considerations
Performance 91.23
(1)
Business cost -77.50
(2)
_________________________________________________________________

a Only the explanatory variables selected by stepwise method up to the


0.05 level of significance are included in this table
b For each variable, data are values of the regression coefficients;
Numbers in parentheses indicate step when entered into the
Corresponding regression.
c Values in brackets are corresponding degrees of freedom for F
Coefficient of the equation.

The overall relationship between the explained variable and the explanatory variables is significant.
The R-square value of .1421 indicates that over fourteen percent variance is explained by the
explanatory variables. The F-value indicates that the regression is significant at .01 significance
level. The regression suggests the relevance of the two indices of performance and business cost
structure. Interestingly, neither the business strategy indicators nor the short-term and long-term
financial indicators appear in the regression equation. In the regression equation with ISOUT as the
explained variable, return on technology and business cost structure, in that order, show significant
explanatory powers. The respective signs of the regression coefficients indicate that a higher return
on technology has a positive effect on IS outsourcing while higher business costs have a negative
effect on IS outsourcing.
In conclusion, only the financial considerations influence the IS outsourcing policies.

3 B. Determinants of Information Systems Productivity


Since IPI (the index for information systems productivity) is explained by another endogenous
variable ISOUT, we need to find the estimated values of ISOUT for the reduced model and then
use these values (instead of original ISOUT data) for the stepwise regression to explain the
variance in IPI. Based on the parameters of the reduced equation for ISOUT, estimated values for
ISOUT were computed and labelled EISOUT. Using the structural equation (3b) for ISP along with
the original indices (factors) for variable F (performance index, long-term index, business cost
index and short-term index) and the EISOUT values, the second-stage stepwise regression was
done. The results of this analyses are presented in Table 4.
Table 4: Determinants of IS Productivity (IPI)

_________________________________________________________________

Explained Variable

_________________________________________________________________
Explanatory Variables a b Information Productivity Index
_________________________________________________________________
R-Square .1210
F valuec [2,81]
5.574
Sig F .005
Constant .2775
A. Financial Considerations
Business cost -.068086
(1)
Short-term -.056296
(2)
_________________________________________________________________
a b c Same as for Table 3

The results of these stepwise regression analyses suggest that financial considerations are the more
important determinants of IS productivity. Specifically, higher business cost structure has a
negative influence on the information productivity index. Similarly, short-term effects of IT
investments on financial performance may adversely effect the IPI. A surprising result is that the
indicators of business strategy do not enter into the regression equation for IS productivity. This
suggests that [within the assumptions of the proposed framework] the strategic position of IS within
the organization, or its competitive resource investment do not have significant influence on the
information productivity. According to the results listed in table 4, the answer to the question
addressed in this study is that financial considerations are the primary determinant of the IS
productivity.

4. Conclusion
Discussion
The paper defined the concept of IS outsourcing policy based upon the decision-making criteria used by
the organizations. This definition was followed by a brief review of the existing debate about the
strategic versus financial basis of the outsourcing decisions. To provide a resolution to this contention, a
conceptual framework that included both decision-making criteria was proposed. Specifically, this
framework was devised to study and compare the influence of business strategy and financial
considerations on the IS outsourcing policy. This comparison was deemed necessary to understand the
relative impact of the two [apparently] disparate decision-making criteria. Existing controversy suggests
that proponents of business strategy as the determinant of IS outsourcing attribute the long-term
problems of outsourcing to decisions based on short-term financial gains. However, most corporate
decisions regarding the outsourcing of IS have been primarily led by prospects of financial savings or
cost-cuttings; in several cases these decisions were based predominately on imitative behavior (Loh and
Venkatraman, 1992b). The proposed framework also aimed to assess the relative importance of financial
considerations and IS outsourcing policy as determinants of IS productivity. It was one of the objectives
of this study to find if IS performance was predominantly influenced by financial considerations or by IS
outsourcing policy.
For the analysis of the proposed conceptual model, the set of one hundred companies considered to be
the most effective users of information technology [by Computerworld Premier 100 survey for 2001]
was chosen. Since the objective of the study is to determine the relationship of the business strategy and
financial considerations to IS productivity, this set of companies represents an admissible sample. The
data on both endogenous and exogenous variables was extracted from secondary sources, specifically
from the Computerworld survey data, the Compact Disclosure electronic database, and companies'
annual reports. Since, the survey data was based on the same [public domain] annual reports of the
companies, data integrity was ensured. A structural equation model was created to represent the
proposed conceptual framework. To satisfy the condition of identifiability, reduced form model was
generated. For operationalization of the model represented by the structural equations, it was deemed
necessary to determine the underlying factors of the variables. Factor analysis was used to combine the
underlying indices of the variables into separate factors. The factor scores for these factors were used in
the structural equations, which were then solved by stepwise regression analyses.
Analysis of the Results of the Study
The results of this study show the relative importance of financial considerations in determining the IS
outsourcing policy and the firm's IS productivity. Surprisingly, business strategy considerations do not
seem to influence IS outsourcing policy. Further, IS outsourcing policy does not seem to have any direct
influence on IS productivity. The empirical findings of the study are summarized below.
a). The evidence in table 3 suggests that only financial considerations are important in influencing the
percentage of IS budget spent outside IS department. Of the financial considerations, performance seems
to positively influence the IS outsourcing decisions, while higher business cost structure has a negative
effect. Business strategy doesn't contribute significantly to the explanation of the variance in IS
outsourcing policy. The internal position of IS or the competitive resource investment apparently do not
influence the IS outsourcing policy.
b). The results in table 4 show that financial considerations are the primary determinant of IS
productivity. IS outsourcing, apparently, has negligible contribution in explaining the variance of IS
productivity. Of the financial considerations, business cost structure and short-term effects of IS
investments on financial performance seem to have a negative influence on IS productivity. A higher
ratio of net income or sales to the IT expenditures does not appear to influence IS productivity.
For the sample included in the study, we infer that financial considerations have a predominant role in
influencing the IS outsourcing policy as well as IS productivity. Business strategy indicators seem to
have negligible influence on IS outsourcing policy. IS outsourcing policy appears to have negligible
influence on IS productivity.
The results from this study discount the role of business strategy and IS outsourcing policy in
determining IS productivity. Only financial considerations appear to be the relevant criteria that
influence IS outsourcing decision as well as IS productivity. However, these results could have been
influenced by the limitations inherent in this kind of study.
Limitations of this study
Considering the fact that this is the first study of its kind which is based on data that is available for only
one year, several limitations must be observed. Firstly, there could have been interactions between the
constructs of business strategy and financial considerations. Such interactions were ignored within the
scope of the present study. Similarly, the study did not take into account the interactions between
financial considerations and IS outsourcing policy in the determining their influence on IS productivity.
Secondly, this study is based on a cross-sectional sample of the hundred most effective users of IT.
Since, data for only one year [with the new Computerworld measure of IS performance, i.e., IPI] was
available at the time of this study, a longitudinal study could not be done. For further research it is
recommended that a longitudinal sample be considered along with the cross-sectional sample. Thirdly,
within the scope of this study, the data for IS budget spent outside IS department was used as a surrogate
for the IS outsourcing policy. This decision was based on the premise that we were trying to measure the
dependence of the internal IS department on all suppliers - internal or external to the organization.
Further, it was assumed that the percent budget spent outside IS department was an adequate measure
for denoting this dependence on external units. The motivation for choosing this variable was its
presence in the same dataset as that for the other variables considered in the study. Hence, even though it
may not be the most reliable measure, still it represents a measure that is consistent with other measures.
Further, this data was reported for the same year as that for other variables in the study and may not
represent annual data for the preceding years. However, there could be a delay between the allocation of
IS budget [internally or externally] and the resulting effect on IS performance. Within the scope of this
study, this variation was not taken into account. Moreover, it is difficult to ascertain the generalizability
of this study to companies that were not in the Computerworld Premier 100 list. Future research should
take these issue into consideration.
Implications for IS Research and IS Practice
The results of the study are interesting in several respects. Firstly, it can be argued that the results are a
reflection of the measurement process used for estimating IS productivity. Since only financial measures
are used for determining the index for IS productivity (IPI), only financial parameters appear to be
significant in the overall analysis. One explanation for this argument is that even the new measure of IS
performance used by Computerworld, although intended to give due emphasis to management of IS
[that could be argued to have positive correlation with IS strategy], has not sufficiently succeeded in its
objective. Another interesting revelation from the study is regarding inconsequential significance of the
internal position of IS function and the budget allocation to IS function in influencing IS performance.
This finding can be explained on the basis of the indirect influence of IS investment on the
organizational IS performance measures such as IPI. Since, we are trying to determine the influence of
the investment in IS on the overall organizational measures, it might be difficult to establish this
relationship unless some mediating variables are considered. Such mediating variables could relate to a
process-level or function-level contribution of the IS function instead of the overall organizational level
contribution. Another approach for determining the value added by investments in IT could compare the
market value of the IS function [determined by the value that the IS function has in the free market] with
alternative [internal or external] options available to the organization for supporting its information
infrastructure. Further research in IS outsourcing can reveal more reliable and valid findings by taking
into consideration the findings of this study and the limitations mentioned herein
* DATA for research has been taken from the website of computer world leadership stats.

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