Outsourcing Alliances: A Strategic Alternative for IT Capable Companies

By

Theophanis C. Stratopoulos Department of Decisions Sciences

University of New Hampshire theos@unh.edu

Peter Lane

Department of Management University of New Hampshire

peter.lane@unh.edu

And

Mihir A. Parikh Department of Management Information Systems

University of Central Florida mihir.parikh@bus.ucf.edu

ABSTRACT While previous research has focused on choosing between insourcing or outsourcing, no systematic attempt has been made to find a viable alternative for IT capable companies, which need to realize optimum value from their IT capabilities. This study reviews the IT outsourcing and strategic management literature and identifies outsourcing alliances as a strategic alternative to the traditional arms-length outsourcing for IT capable companies. By building an outsourcing alliance with complementary partners, an IT capable company can go beyond its internal market for IT services to provide similar and, even new, IT services to third parties. Grounded in transaction cost economics, relational theory, and the theory on reciprocal learning alliances, this study develops a model in which the IT capable company can earn collaboration-, transaction-, and firm-specific quasi rents through outsourcing alliance. Keywords Outsourcing, Business Value of IT, IT capability, competitive advantage, relational theory, transaction cost economics, reciprocal-learning alliances.

2

1. INTRODUCTION

Over past two decades, IT outsourcing has grown dramatically in terms of both

the volume and the sophistication of deals. The importance of this trend has lead

researchers to examine many aspects of IT outsourcing including best practices (Lacity

and Willcocks 1998), drivers and determinants (Clark et al 1995; Loh and Venkatraman,

1992; Goo, et al 2000), risks and benefits (Lacity and Hirschheim, 1993), hidden costs

(Barthelemy, 2001), and client-vendor relationships (McFarlan and Nolan, 1995; Klepper

1995; Kern, 1997; Kern and Willcocks 2000, 2002; Lacity and Willcock 2000).

These studies have identified two primary reasons for outsourcing: to receive IT

services that are required but not available from the internal IT organization, perhaps due

to the lack of skills or capital; and to reduce the cost of IT operations. For the

organizations that have limited internal IT capabilities, outsourcing provides a quick and

cost-effective way to acquire necessary IT services. However, for the IT capable

organizations, i.e. the organizations with “overall ability to sustain IT innovation and

respond to changing market conditions through focused IT applications” (Bhardwaj, et al.

1999, p. 381), outsourcing is simply a cost-cutting measure. Many studies have found

that outsourcing only for the cost reduction purposes has often not been successful.

In this paper, we discuss an alternate for IT capable companies to reduce cost by

leveraging their internal IT capabilities to explore external markets through outsourcing

alliances. We define outsourcing alliance as, “an alliance formed by a firm’s internal IT

organization with one or more organizations, with marketing, complementary IT, or

other capabilities and resources, for the purpose of using its internal IT capabilities to

3

provide IT services to other organizations.” Outsourcing by Cathay Pacific Airways

provides a good example to illustrate our argument (McFarlan and Young, 2003).

Over the years, this Hong Kong-based airline’s IT organization grew with the

company and was developing and managing internal IT needs. Its data center was

responsible for coordinating fundamental airline IT services such as reservations,

ticketing, cargo handling, etc. These services are critical for all major airlines and require

a robust IT infrastructure. In 1997, during a period when Cathay was under a lot of

pressure to cut costs, it decided to outsource its data center to IBM Global Services. A

few years later, IBM used the former Cathay data center to serve several dozens of

clients, including a number of major airlines in Australia, Korea, and Japan. Evidently,

IBM Global Services combined its own marketing and other expertise with the

‘outsourced’ IT capability of Cathay’s data center and the talented pool of Cathay

employees, to gain a successful regional presence for itself. Meanwhile, Cathay was

preparing for another round of IT outsourcing. An alternate for Cathay might have been

to form an alliance with IBM or similar companies to combine their expertise with its

internal IT capabilities and turn its IT organization into a revenue center by offering the

services to other organization, including other airlines.

While several studies have examined outsourcing as a way of acquiring required

IT capabilities at a lower cost, here we present a unique outsourcing possibility for some

IT organizations in which they increase their contributions beyond simply meeting the

internal IT needs of their parent firms by outsourcing their own IT capabilities through

outsourcing alliances. We develop theoretical basis for such outsourcing alliances

through transaction cost economics, relational theory, and reciprocal learning alliance

4

perspectives. We expect the theoretical base would help researchers to understand better

the diverse and complex set of outsourcing options and unify this unique outsourcing

option with other research in outsourcing (Bacharach, 1989). Building on the work of

Madhok and Tallman (1998), we also articulate transaction-, collaboration-, and firm-

specific quasi rents, which make outsourcing alliance a viable alternative for IT capable

companies.

The remaining paper is organized as follows: The next section presents a

constrained value adding maximization problem faced by IT organizations that service

internal markets. We expand to model to include opportunity cost incurred by IT capable

companies and illustrate the natural shift toward outsourcing as the quantity of the IT

services used by the company increases. The third section offers outsourcing alliance as

an alternative for IT capable companies. Outsourcing alliances provide IT services to

third parties with an aim to realize optimum value for the IT capable company. The

fourth section discusses viability of outsourcing alliances with special focus on quasi

rents generated by them and offers overall value creation framework. The fifth section

identifies implications for research and practice. The final section provides conclusions

and directions for future research.

2. IT ORGANIZATION SERVING INTERNAL MARKETS

The main objective of the IT organization of a company is to maximize the value

of its contribution to the company. This goal will materialize to the extent that the IT

organization delivers the portfolio of desired IT services (the effectiveness aspect) at the

lowest possible cost (the efficiency aspect). Given most IT organizations provide IT

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services only to their own companies, this can be captured in the following constrained

value adding maximization problem [1]1:

HH

HHHHHHHH

QQts

DQGDQCQDQPVˆ..

)},ˆ(),({*),(max

≤

+−= [1]

Where:

VH is the net value that the IT organization contributes to the company; PH is the

internal transfer price for an IT service delivered; D is the quality of the IT service based

on its design/customization; QH is the quantity of the IT service delivered by the internal

IT organization; Q̂ H is the total quantity of the IT service that the internal IT organization

can profitably deliver; PH(.) represents the internal demand curve for the IT service;

PH(.)QH represents the gross value that the IT service adds to the parent company.

Assuming a typical downward sloping demand curve, the function and shape of PH(.)QH

will be strictly concave.

CH(.) represents the development and support cost of the IT service and it is the

sum of these two costs. Development cost is primarily driven by the quality of the IT

service [ )(DCC tDevelopmen = ]; it is high during the early stages of systems development

lifecycle and reduces as the development lifecycle completes over time. Support cost is

primarily driven by the quantity of the IT service [ )|( DQCC HSupport = ]. It is relatively

low during the early stages and gradually increases over time, because the IT

organization needs to support more users [QH] as they adopt the IT service. Once the

application has been completely adopted within the company the support cost is almost

flat and the only chances for increase will be associated with such things as employee

1 See Appendix A for properties of VH.

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turnover, training, support etc. Governance cost [ (.)HG ] is the cost of managing the IT

capabilities via an internal hierarchical structure. The cost of managing the IT capability

relates to [ Q̂ H] the total quantity of the IT service that the internal IT organization can

profitably deliver.2

This maximization process is subject to the constraint that the IT service delivered

by the IT organization [QH] is less or equal to the maximum quantity of IT services [ Q̂ H]

the IT organization can profitably deliver. When the IT organization cannot deliver the

quantity of the IT service required by the company at a specific quality, it would have to

pursue an external source for the additional needs, which would be categorized as IT

outsourcing. However, when the IT organization has higher IT capabilities than those

used by the company, there is an opportunity cost of not using those capabilities to

generate additional rents.

2.1. Opportunity Cost

From an economic standpoint, the IT organization ought to utilize its IT

capabilities in areas with the highest value adding potential, i.e., minimize the

opportunity cost. By servicing only the internal market, the IT organization is incurring

the opportunity cost related to not utilizing its capabilities for external markets. While

often ignored by IT organizations and companies, this cost can significantly change the

2 Asset specificity (AS), the degree to which assets can be redeployed without losing their value, is a significant attribute of governance cost when comparing alternative governance structures (Williamson, 1981). AS is not included in GH(.) because we concentrate on the internal IT organization. We will introduce AS in GH(.) and we will discuss its shape in detail in our Discursion of Transaction-Specific Quasi Rents when we compare alternative governance structures.

7

net value added by the IT organization. The equation [1] is revised below to reflect this

opportunity cost.

HH

HHHHHHHHHH

QQts

ASDQODQGDQCQDQPVˆ..

)},,ˆ(),ˆ(),({*),(max

≤

++−= [2]

Where: OH(.) is the opportunity cost of not fully utilizing the IT capabilities of the

IT organization; and AS is the asset specificity, i.e., the degree to which IT assets used by

the IT organization can be redeployed to serve internal and external markets without

losing their value. Opportunity cost is primarily driven by AS [ ),ˆ|( DQASCO HH = ] and

its value increases as AS decreases. High AS implies that the IT assets are unique, hence

useful only to the company (low opportunity cost). Low AS implies that the IT assets are

not unique, hence also useful to external markets (high opportunity cost).

During the early stages of systems development life cycle (planning, analysis and

design, development), when the quantity of IT service delivered by the internal IT

organization [QH ] is low, the AS is high. On the other hand, during the late stages of

systems development life cycle (maintenance and end-user support), when QH is high, the

AS is low (Grover et al., 1996).

We illustrate the decomposition of the IT organization’s cost structure

[CH(.)+GH(.)+OH(.)] as the sum of development Cost [ )(DCC tDevelopmen = ]; support cost

[ )|( DQCC HSupport = ]; Governance cost [ (.)HG ], and opportunity cost

[ ),ˆ|( DQASCO HH = ] in Figure 1.

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2.2. Overall Value Proposition of IT Organization

Figure 2 captures the incremental net value added [VH] during the lifecycle of a

typical IT service as the difference between the gross value added [PH(.)QH] and cost

structure [CH(.)+GH(.)+OH(.)]. The shape and shifts in the net value added curve will be

driven by changes in the gross value added and cost structure.

As the quantity of the IT service offered by the IT organization increases, the

change in the value added by the IT organization can be partitioned into three stages: 1)

the added value is initially negative but increases with quantity to a breakeven point; 2)

the added value is positive and increasing; 3) the added value is initially positive but

diminishing and eventually becomes negative. During the first stage, the incremental net

Figure 1 Cost Structure

CH+GH+OH

COpportunity

GH

CSupport

CDevelopment

$

QHigh Asset Speficity Low Asset Speficity

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value added of the IT service is primarily driven by the high development cost. Support

cost is negligible, as the company has not adopted the IT service in its operations. Asset

specificity is high and the opportunity cost is low.

Figure 2 Net Value Added [VH]

$

Q

PH(.)QH

VH

[ STAGE 1 ] [ STAGE 2 ] [ STAGE 3 ]

CH+GH+OH

During the second stage the value added is positive and rising at a decreasing rate.

This rise is fueled by a successful transition of users from an old, inefficient, and

ineffective process to a new one enabled by the IT service. This implies that users can

exploit the IT service to contain the cost per transaction and in operations, as well as to

exploit opportunities for revenue increase (growth). In this second stage, while

development cost is quickly diminishing as major bugs have been removed from the IT

service, support cost is increasing rapidly as new users are added continuously to the new

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system. Opportunity cost remains relatively low as the IT resources are employed in a

high value-adding project. However, success brings peer-recognition and the competitive

mechanism is set in motion as competitors adopt or start developing similar IT

systems/services leading to a gradual decline of the related IT system’s asset specificity.

In the third and final stage, the value added is initially positive, though

diminishing and gradually approaching zero. However, given the positive relationship

between asset specificity and net value added at low levels of asset

specificity ⎟⎠

⎞⎜⎝

⎛>

∂∂

0ASVH , the continuous decline in AS implies that the net value added

[VH] will eventually become negative. Two empirical studies found evidence relating the

visibility of an IT capability (Dehning and Stratopoulos, 2003) or strategic initiative

(Chen and Miller, 1994) to firm performance. The former study found the higher the

visibility of an IT capability, the smaller the duration of its competitive advantage. The

latter study found that highly visible strategic initiatives potentially had an adverse effect

on financial performance.

In the context of our analysis, the effect of peer recognition will lead to increasing

adoption of the IT service as ‘best practice’ within the industry. This further diminishes

the value of the asset specificity related advantage. In the meantime, while the

development cost is minimal and the support cost has plateau, the opportunity cost is

rising as the IT resources are tied up to what is gradually becoming an industry-best

practice. As asset specificity further decreases, the opportunity cost increases

significantly for the IT organization.

We moved over time from a period when scarcity of the IT service was the source

of rent (Ricardian rent) to a period when the source of rent was associated with the

11

immobility of the resource due to its association with the particular IT capable firm

(Pareto quasi rent). In the end, technological developments and market forces gradually

eroded the asset specificity leading to the commoditization of the IT service and an

elimination of all IT enabled rents.

2.3. Natural Shift Towards Outsourcing

As the net value added decreases over time, the company needs to make a

decision regarding the future governance of the IT service. Either maintain the current

structure (hierarchy governance mode) or outsource the IT service to a vendor (market

governance mode). From a competitive standpoint, trying to maintain a hierarchical

structure in the face of increased commoditization (declining AS) is a Sisyphean task. The

outsourcing option would be to acquire all IT services from the market. Outsourcing

assumes that vendor enjoys economies of scale (e.g. large dedicated IT services

companies like IBM, EDS, and HP) or operates in a low cost environment (e.g. offshore

companies like TCS, Infosys, and Wipro). Thus, they would be able to offer a greater

value proposition. The net value adding maximization problem for the outsourcing

scenario would be:

_..

)},,(),({*),(max

QQts

ASDQGDQCQDQPV

H

HMHMHHMM

≤

+−= [3]

Where: VM is the net value that the company enjoys by acquiring the IT service

through the market, i.e., through an outsourcing vendor; PM(.) is the company’s demand

curve for the externally provided IT service; CM(.) is the cost that the vendor charges for

12

delivering the IT service; GM(.) is the cost of maintaining a arms-length relationship with

the vendor; and _Q is the maximum quantity of IT service that the company can absorb.

Outsourcing would be beneficial for the company if the net value added of the IT

organization is lower than the value of outsourcing [VM > VH]. With assumption of non-

changing demand curves [PH(.)=PM(.)], that would be possible if the vendor’s cost

structure is lower than that of the internal IT organization,

i.e. (.)}(.){ MM GC + < (.)}(.)(.){ HHH OGC ++ .

Companies have made decision regarding outsourcing based on these two polar

governance modes - insourcing and outsourcing. However, in the next section, we

propose outsourcing alliances as an intermediate alternative for IT capable companies.3

3. OUTSOURCING ALLIANCE SERVING EXTERNAL MARKETS

The model in the previous section captures the spirit of the problem that the IT

organization is facing in the sense that it deals with both efficiency and effectiveness in

the context of a limited internal market [ HH QQ ˆ≤ ]. The IT organization is evaluated in

its ability to deliver the optimum amount [QH] and quality [D] of the IT service at an

internally accepted price [PH] while trying to maintain a competitive cost structure.

IT services, historically, have been support activities (Porter and Millar 1985).

Therefore, the market for the IT capabilities of the IT organization is limited within the

domain of the company. From a competitive standpoint, a comparison of the IT

organization with external providers would put it in a position of relative disadvantage

3 Our proposition is inline with the recommendation of Lacity and Willcocks (1998) for selective outsourcing as a more successful outsourcing approach.

13

due to its captive-supplier positional inability [ HH QQ ˆ≤ ]. Thus, the company might not

be able to fully appropriate the potential rents associated with its IT capability due to

internal market limitations. The size of the internal market becomes a binding constraint

that determines the upper limit in terms of gains in both effectiveness and efficiency that

the IT organization can attain. Further gains could be obtained by exploiting economies

of scale and scope. However, this implies offering the IT service to third party clients.

An IT organization may be fully capable in terms of the technical aspects of the

IT service to provide it to third party clients. Nevertheless, given the inherent lack of

marketing and capital structures in internal IT organizations, the IT organization may not

have the skills necessary to market and manage external contracts with third parties. In

some cases, it may even need complementary IT capabilities to offer a stronger value

proposition to third parties. Thus, they need to build an outsourcing alliance with one or

more organizations that have marketing, complementary IT, or other capabilities and

resources. In this alliance, the company contributes its expertise in developing and

supporting an IT service and the alliance partner contributes its expertise in managing

and marketing the sale of the IT service to third party clients. The objective is to use

internal IT capabilities to develop and offer IT services that other organizations may find

valuable.

The option of outsourcing alliances not only removes the “market size” constraint

from the value adding maximization problem but also offers unique competitive

opportunities to the partnering companies to exploit governance efficiency, as well as

economies of scale and scope. While continuing to serve the company’s internal market,

14

the alliance would also provide the IT service to other organizations as well as develop

additional IT service. This leads to the following value added maximization model [4]:

}{00..

),,,,();,,(

*),,(*),,(*),(max

≥>

+++−

−++=

ITNewA

ITNewAHAITNewAHA

ITNewITNewITNewAAAHHHA

QandQts

ASDQQQGSASDQQQC

QASDQPQASDQPQDQPV

[4]

Where:

VA is the portion of the net value that the alliance adds to the company; PH(.)QH is

the gross value that the IT organization adds to the company’s internal market; PA(.) is

the external (alliance’ clients) demand curve for the existing IT service; QA is the quantity

of the IT service sold through the outsourcing alliance to third party clients; PA(.)QA is the

gross value generated for the company by the alliance through its service to third party;

PNew IT (.) is the demand curve for a new, alliance-developed IT service; QNew IT is the

quantity of the new IT service sold through the outsourcing alliance; PNew IT (.)QNew IT is

the gross value generated for the company by the alliance through its new IT service.

CA(.) is the cost of supplying the IT service [QH+ QA+QNew IT ], while capturing the

positive effects of combinatorial economies of scope [S]; GA(.) captures the transactional

governance costs of supplying the IT service through an outsourcing alliance. Since the

alliance enables the IT organization to optimize the allocation of its resources, hence

capture the full rent from its IT capabilities, the opportunity cost is negligible. The

constraint QA>0 captures the fact that the alliance would not exist unless it manages to

generate new clients. The constraint QNew IT ≥ 0 captures the fact that the alliance may

develop new IT services through synergy between the IT organization and its alliance

partner.

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In the following section, we will leverage various management theories,

transaction cost economies, relational theory view, and reciprocal learning alliances, in

order to better understand the theoretical basis for outsourcing alliances.

4. DISCUSSION

Building on Madhok and Tallman (1998), we argue that IT capable companies

will enter into outsourcing alliances because they are expected to yield superior value

added when compared to alternate governance forms. The value of an outsourcing

alliance arises from its ability to generate transaction-specific, collaboration-specific, and

firm-specific quasi rents for its members.

Transaction-specific quasi rents occur due to the unique transaction undertaken

through the formation of the outsourcing alliance. According to Williamson (1981; pp.

1543-44) transaction costs include “ex ante costs of negotiating and writing as well as ex

post costs of executing, policing, and, when disputes arise, remedying the explicit or

implicit contract that joins them.” An outsourcing alliance will yield transaction-specific

quasi rents for the IT capable company if:

),ˆ(),,(),,,,( DQGASDQGASDQQQG HHHMITNewAHA ≤≤

Collaboration-specific quasi-rents arise from the combination of resources of both

partners into a synergistic bundle that enables them to attain value added levels which the

partners could not have been able attain individually (Madhok and Tallman 1998). An

outsourcing alliance will yield collaboration-specific quasi rents for its members through

three possible venues: First, through revenue growth from optimal utilization, i.e. the

company offers the same IT service to third party clients:

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0*),,( ≥AAA QASDQP

Second, through revenue growth from economies of scope, i.e. the alliance

partners can develop new IT services:

0*),,( ≥ITNewITNewITNew QASDQP

Third, through production efficiencies:

H

HH

M

HM

ITNewAH

ITNewAHA

QDQC

QDQC

QQQSASDQQQC ),ˆ(),();,,(

≤≤++

++

Firm-specific quasi rents stem from resources and capabilities which are valuable,

rare and not easily replicable by the competition. An outsourcing alliance may generate

such rents for its partners through positive spillovers. The IT capable company may be

able to develop new knowledge which when combined with its unique resources may

increase the company’s rent-generating capacity outside of alliance (Khanna 1998;

Madhok and Tallman 1998; Lubatkin, Florin and Lane 2001). In the following sections

we discuss, how these rents are appropriated and develop specific proposition for each.

4.1. Transaction-Specific Quasi Rents

Transaction cost economics (TCE) provides the foundation for understanding

transaction-specific rents in outsourcing alliances. TCE has been one of the most favored

frameworks when it comes to questioning which activities to perform within the firm,

which to perform outside, and why (Williamson 1981b, 1985) and specifically in IT

outsourcing (Ang and Straub 1998; Aubert, et al. 2004; Ngwenyama & Bryson 1999). It

makes the transaction, rather than the product or service, the basis of analysis to evaluate

the ability of governance structures in determining the most efficient mode of structuring

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and managing the transaction (Ngwenyama & Bryson 1999). If transaction costs are

substantial and exceed the production cost advantages of market, a firm will make

components in-house and vice versa (Williamson 1991). Thus, as transaction cost

increases, it erodes the benefits of production cost made available by IT outsourcing

vendors (Ang and Straub, 1998). Among the dimensions of transaction costs, asset

specificity has played an essential role in determining the degree of transaction cost and

its corollary on the make-or-buy decisions (Williamson 1991). In IT outsourcing, as

asset specificity increases, the contractual clauses become more complex and numerous

leading to greater transaction cost (Aubert, et al. 2004).

While hierarchies and markets are the main alternatives, Williamson (1991)

introduced the hybrid mode, the equivalent of outsourcing alliance in the context of this

study, as an alternative to the two polarizing governance modes. The hybrid or mixed

mode, is considered as being an in between governance structure with respect to the three

governance characteristics of incentives, adaptability, and bureaucratic costs. In the spirit

of Williamson’s argument we have that the outsourcing alliance, by preserving some

ownership autonomy helps the partners maintain strong individual incentives in their area

of expertise and encourages adaptation to market and technological disturbances to which

one party corresponds efficiently without consulting the other. However, because of the

strong dependency between the partners, long-term contracts are supported by elaborate

contractual agreements. Compared to an arms-length outsourcing deal, the outsourcing

alliance sacrifices individual incentive intensity in favor of superior coordination among

the partners. When compared with the hierarchy, the outsourcing alliance sacrifices

cooperativeness in favor of greater individual incentive intensity.

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The above argument is summarized in Figure 3, which expresses governance

costs for each one of the considered governance structures – internal IT organization or

hierarchy, outsourcing alliance or hybrid, and market or third party arms-length

outsourcing vendors - as a function of asset specificity.4

Three aspects are important in Figure 3. First, the intercept for market

governance cost is higher than the intercept of the hierarchy and the slope for market

governance cost is dropping at a faster rate than the slope of the hierarchy at the high AS

range. The slope for the hierarchy is relatively flat as asset specificity does not

significantly influence governance cost in the hierarchical forms. High asset specificity

4 Figure 3 is an adaptation of a figure from Williamson 1991, page 284.

Figure 3 Transaction Specific Quasi Rents

19

may require slightly more specialized governance mechanisms than low asset specificity,

but the difference is marginal and insignificant compared to that for other forms.

)|,()|,,,()|,ˆ( maxmaxmax === ≤≤ ASDQGASDQQQGASDQG HMITNewAHAHH

( ) ( ) ( )ASASAS ∂∂

<∂∂

<∂∂ MAH GGG

This reflects the fact that the bureaucratic costs of the market are higher than

those of the internal IT organization, if asset specificity is high, but they fall at a faster

rate as asset specificity is declining. In addition to high asset specificity, the significant

difference in the intercepts between the market and hierarchies can be attributed to

uncertainty and fear of opportunism (Williamson 1979). Assuming that the development

and support of an IT service, which requires investment in highly specialized assets, were

to be arranged to be delivered by a bilateral market agreement, both client and vendor

would want safeguards against the risk of opportunistic behavior. If asset specificity is

high it is not easy for the client to switch to another vendor or for the vendor to find

another client. Safeguarding against such risk increases the governance cost and an

environment of uncertainty can make it higher. The introduction of an innovative IT

service is likely to coincide and contribute to environmental uncertainty. Delivery of

such a service through a market mechanism implies that neither client not vendor could

be able to anticipate all possible contingencies (bounded rationality), and they need

safeguards against such an uncertainty.

Second, the intercept and slope of the governance cost of the outsourcing alliance

is in between those of the internal IT organization and market. The intercept of the

outsourcing alliance will be lower than the market mode and closer to a hierarchy,

because the risk of opportunistic behavior and uncertainty is smaller in a transaction that

20

is determined by a common goal rather than pursuit of individual interests. As the asset

specificity is declining, the slope of the outsourcing alliance will drop at a faster rate than

that of the internal IT organization and closer to that of a market’s governance structure

because the alliance will behave like a market model.

Third, from an economizing standpoint a firm should move along the lower

‘envelope’ of governance structure as asset specificity is declining. The interpretation of

Figure 3 can be seen as an extension of our discussion on Figure 2. At the early stages,

the IT organization introduces an innovative IT service with high asset specificity and the

company will exploit the Ricardian type of rents. The gradual decline in asset specificity

(scarcity) will be counterweighted by the fact that the IT service has been introduced by

an IT capable company leading to a transition from Ricardian to Pareto type quasi rents.

From a governance standpoint, the hierarchical mode remains the most efficient form of

governance. However, as a result of technological developments and increased

competition, the degree of commoditization of the IT service is increasing, and the parent

company will need to start re-evaluating their governance options (hierarchy, hybrid, and

market).

In Figure 3, we are sliding along the hierarchy curve towards point A and the

company will have to choose one of the following paths: Fist, continue offering the IT

service internally. This means a movement along the AB range on the hierarchy curve.

Second, divest the resources related to the IT service by entering into an arms-length

outsourcing deal. This scenario is captured by a movement along the AB range in the

hierarch curve, and then along the BC range on the market curve. The reduction in

governance cost as a result of the switch from a hierarch to a market structure is captured

21

in area between the market and hierarchy curve to the left of point B. In the last path, an

IT capable company that considers an outsourcing alliance will move along the lower

(efficient) frontier by transitioning from hierarchy to hybrid to market. The shaded area

in Figure 3 captures the incremental reduction in governance cost.

∫∫ −+−=∆ C

B

B

A

AS

AS AM

AS

AS AH GGGGG )()(

This leads to the following propositions:

P1a: The likelihood that the outsourcing alliance will be able to appropriate

transaction-specific quasi rents is increasing as asset specificity declines, i.e. the IT

service is approaching the commoditization stage.

P1b: The magnitude of transaction-specific quasi rents decreases as the asset

specificity declines.

4.2. Collaboration-Specific Quasi Rents

One of the limitations of TCE is the fact that it concentrates on transaction costs

and governance efficiencies. This means that the only benefits that the partners of an

outsourcing alliance jointly exploit are associated with transaction specific quasi rents.

Such an approach might have been appropriate had we adopted a more restrictive

definition of outsourcing alliances. However, we have adopted a definition that expands

the a la Gurbaxani (1996); DiRomualdo and Gurbaxani (1998) commercial exploitation

of IT products or services by both partners. The exploitation of such benefits is

contingent on their ability to evaluate and absorb external knowledge and apply it for

22

commercial exploitation in their respective markets (Cohen and Levinthal, 1990) and

production economies of the outsourcing market.

In the following sections we will develop propositions pertaining to collaboration

specific quasi rents. More specifically we will build on relational theory view (RTV) in

order to support our proposition on quasi rents through revenue growth from optimal

utilization; the theory of reciprocal learning alliances (RLA) to support propositions on

revenue growth from economies of scope; and production cost economics to support

propositions on production efficiencies related quasi rents.

4.2.1. Through Revenue Growth from Optimal Utilization

Relational Theory View (Dyer-Singh 1998) has been offered as an alternative to

Industry Structure View and Resource Based View and is built on the premise that a

firm’s capabilities may straddle the firm boundaries and may be embedded in inter-firm

routines and processes. Using the network between firms as the unit of analysis the

theory looks at various aspects of partnerships that have the potential to lead to creation

of collaboration specific rents. Competitive advantage is possible when alliance partners

combine, exchange, or invest in idiosyncratic assets, knowledge and resources, and

employ effective governance mechanisms that lower transaction costs or permit the

realization of rents through the synergistic combination of assets, knowledge, and

capabilities.

The ability of partners to combine synergy-sensitive resources, i.e. resources that

when combined are valuable, rare, and difficult-to-imitate, is a critical determinant of the

alliance’s rent generating potential. This is complemented by investments in

23

collaboration specific assets and inter-firm knowledge sharing routines. However, the

effect of such investments is moderated by the volume of transactions between partners,

the length of the governance arrangement designed to safeguard against opportunism, the

partners’ absorptive capacity, and the alignment of incentives between partners (Dyer-

Singh 1998).

Volume of transactions [QH+QA+QNewIT] relates to the expectations of the

partnering companies regarding the potential of the alliance to generate rents through

revenue growth [ 0*),,( ≥AAA QASDQP ]. The higher are the expectations regarding the

volume of transactions, the more likely that the partnering companies will invest in

relation specific assets. An advantage of the outsourcing alliance is that it starts with an

initial seed [QH] due to high profile captive client (parent company). The partners can

leverage this advantage to attract new clients [QA>0]. In addition to this, the alliance can

leverage its non-adversarial relation with the parent company in order to refine the terms

and conditions of new transactions. The experience can be used in the design of

attractive service level agreements that could be used to attract and retain external clients.

Volume is not enough unless it lasts for a relatively long time. This brings to the

issue of the duration of an outsourcing alliance and an often-visited research topic, the

optimum length of outsourcing contract. Lacity and Wilcock (2000), among several

others, argue that long-term deals tend to be less successful. Difference in incentives

between clients and vendors, as well as lack of flexibility has been the main reasons why

clients should avoid long-term contracts (Harrigan and Newman, 1990; McFarlan and

Nolan, 1995). However, while these limitations are valid in the case of arms-length type

24

of outsourcing, it is clear that they are less binding in the case of an outsourcing alliance,

primarily due to better alignment of incentives between the partners (Lacity et al. 2003).

While the importance of the alignment of incentives has a long history in the IS

research literature (Harrigan and Newman, 1990; McFarlan and Nolan, 1995; Lee, 2001;

and Lacity et al. 2003), the interest in absorptive capacity and knowledge management is

more recent (Sambamurthy and Subramani, 2005; Malhotra et al., 2005). Lee (2001) has

found some empirical evidence validating the effect of the ability of partners to absorb

shared knowledge on outsourcing success.

While the alliance can hope to attract and retain new customers by leveraging its

unique combination of synergistic resources and alignment of incentives, its efforts are

likely to be undermined by a decline in asset specificity. Such a decline implies a

commoditization of the IT service and an increased likelihood that other vendors might

enter the market and offer similar services. Thus, we propose:

P2a: The existence of synergistic resources and alignment of incentives between

the IT capable company and outsourcing alliance partner will positively affect the

volume and length of transactions leading to revenue growth related

rents 0*),,( ≥AAA QASDQP .

P2b: The positive effect on revenue growth will be mitigated by a decline in asset

specificity.

4.2.2. Through Revenue Growth from Economies of scope

The theory of Reciprocal Learning Alliances (Lubatkin, Florin and Lane’s 2001)

is built on the concept of cooperative learning in the sense that both partners co-learn and

25

co-experiment by simultaneously being students and researchers. The primary goal of

partnering firms engaging in a reciprocal learning alliance (RLA) is to leverage each

others’ knowledge structure in order to develop products or services that neither one of

the partners could develop individually in a competitive manner.

Economies of scope are a simple example of how reciprocal learning could

generate additional benefits for the alliance. The vendor has the expertise to foresee the

fact that when modified the IT service could be offered to clients outside the area of

expertise associated with the parent company and the IT organization could deliver the

necessary changes leading to the creation of the new IT service.

To accomplish this goal both companies can agree that the IT capable company

would become the testing ground. The place where both partners develop their unique

expertise, such as fine tuning the service, developing the delivery and support

mechanism, service level agreements, pricing, etc. Once the product has been developed,

the initial benefits will come from the excess earnings of the parent company (short term

benefits). However, the long term benefits stem from the selling of the services to third

party clients. Hence, the outsourcing alliance has the potential to evolve into a RLA that

can generate firm as well as collaboration specific quasi rents.

0*),,( ≥ITNewITNewITNew QASDQP .

According to Lubatkin et al. (2001) the prerequisites for successful cooperative

learning are resource, goal, and task interdependence. Resource and task

interdependence means that each learning partner contributes an important and unique

piece of the information puzzle and specialize their efforts towards activities at which

they are individually most competent. Continuing with our economies of scope example,

26

one may be led to believe that the contribution of the IT capable company (know hows) is

neither important nor unique. However, such a belief is inaccurate. Empirical and

anecdotal evidence points to the contribution of effectively deployed IT on firm

performance (Sambamurthy 2000; Dehning and Stratopoulos 2003). The ‘know hows’ of

the IT capable company reside in a form of tacit knowledge in the IS area of the parent

firm. Such knowledge is built over a period of time and it is the result of a good

understanding of the parent firm’s production processes information needs, and

idiosyncratic developments (Nam et al. 1996).

Goal interdependency is the third prerequisite for successful cooperative learning.

In the context of an outsourcing alliance it is clear that while, theoretically, either one of

the partners could develop the knowledge structure individually, such an approach may

not be the most appropriate given the rate or technological innovation and competition

surrounding IT services. Both partners, client and vendor, understand that the potential

for modifying an existing IT service for a new market class or developing a break

through innovation are much higher compared to what each one of them could have

accomplished individually. In the process of working together they accomplish more.

Another characteristic of an outsourcing alliance that contributes to its probability

to evolve into successful reciprocal learning alliances is the fact that, by default, the two

partners operate in two different markets.5 Hence the risk of directly competing with

each other is minimal. This means that the risk of opportunistic behavior is relatively

5 The above discussion is based on the assumption that the outsourcing alliance is between the IT capable company and the vendor. However, if one considers the alliance as being between the IT department of the client and the vendor then there is the potential market overlap and subsequently a risk of opportunistic behavior.

27

small and the partners are more likely to disclose their knowledge disclosure and be more

forthcoming (Lubatkin et al. 2001). Thus, we propose:

P3a: The synergy in the outsourcing alliance leads to the development of new IT

services supporting revenue growth [ 0*(.) ≥ITNewITNew QP ] from economies of scope

P3b: The ability of the alliance partners to exploit economies of scope related

rents [ 0*(.) ≥ITNewITNew QP ], increases with resource, goal, and task interdependence.

P3c: The ability of the alliance partners to exploit economies of scope related

rents [ 0*(.) ≥ITNewITNew QP ], increases with their absorptive capacity.

4.2.3. Through Production Efficiencies

While a sustained higher volume of repeating transactions is one of the sufficient

conditions for the success of an outsourcing alliance, relating higher volume to revenue

growth captures only half of the desired effect. It is equally important to examine the

role of volume and length in the context of the cost structure of the IT service6.

Production cost related rents that the IT capable company can exploit by transitioning

from an internal (hierarchical governance) structure to an outsourcing alliance. Such

quasi rents are feasible if the long-run production cost of the IT service follows

increasing economies of scale (increasing returns) pattern.

Understanding the nature of long run operations of the offered IT service is

important for illuminating the production cost related quasi rents. In general, there are

three scenarios related to returns to scale: increasing, decreasing, and constant returns to

6 In the rest of the discussion instead of saying the operating cost of the IT service offered by the IT department through an outsourcing alliance, we simply say the operation cost of the IT department.

28

scale. A company is operating under increasing returns to scale or economies of scale if

its product (IT service in this study) more than doubles with a doubling of the inputs. If

the IT outsourcing market is described by such operating conditions we are more likely to

observe a small number of large outsourcing vendors offering IT services at a relatively

low cost per unit of transaction. Vendors (and IT organizations) unable to attain the

desired volume will fall in a position of competitive disadvantage, as they will find

themselves operating at a relatively high cost per unit.

For companies that are subject to constant returns to scale, an increase in all

inputs will lead to a proportional increase in output. In other words, the size of the

vendor’s (and the client’s IT organization) operations does not affect the productivity of

its resources. The per-unit cost of an outsourcing vendor servicing a large number of

clients/transactions is more or less the same as that of an internal IT organization serving

the limited, in terms of quantity demanded [QH] needs of its parent company.

Under decreasing returns to scale the increase in output is proportionally smaller

than the increase in inputs. Obviously, in an outsourcing market characterized by such

operating conditions, small vendors and/or internal IT organizations are better suited to

meet the market’s needs for IT services since they can operate at a relatively lower cost

per unit.

Recent studies point to the increasing maturity of both the demand and supply in

the outsourcing market (Carmel and Agarwal 2002; Rottman and Lacity 2004), leading

to simultaneous increase in the supply and demand of outsourcing IT services. This trend

is reinforced by the fact the smaller firms (internal IT organizations) are unable to

compete against the larger firms (outsourcing vendors) in terms of cost. In the context of

29

long run production costs this implies that the outsourcing market – at least for IT

services which are approaching or close to their commoditization stage – is experiencing

increasing economies of scale.

Overall, the difference, drop, in the per unit production cost of the IT services will

reflect the production-related quasi rents that the IT capable company can enjoy and the

alliance can leverage to support a low cost strategy in the promotion of the service to

external clients. Thus, we propose:

P4: With increased volume of IT services [ ITNewAHH QQQQ ++≤ ], an outsourcing

alliance will be able to attain lower per unit operating cost than the IT organization

might attain by offering the service internally to the company.

H

HH

M

MM

ITNewAH

ITNewAHA

QDQC

QASDQC

QQQSASDQQQC ),ˆ(),,();,,(

≤≤++

++

4.3. Firm-Specific Quasi Rents

In our discussion on quasi rents through revenue growth from economies of

scope; we built on the theory of reciprocal learning alliances in order to support our

argument that partners could jointly develop new IT services. The process of jointly

developing new services is likely to generate two types of positive spillover effects

leading to firm-specific quasi rents for the IT capable company.

We can visualize the first round of positive spillover effects if we assume a

scenario, a la BAE Systems and Xchanging.7 In this scenario, one of the partners - the IT

capable company in our case - would become the greenhouse for the development and 7 See Lacity et al. 2003

30

fine tuning of this new IT service. Hence the company will be the first among its

competitors to use the new service and its users will benefit from their close interaction

with the development team. While the valued adding contribution of the former of these

benefits might be contested, the importance of the latter has been well accepted in both

academic and practitioner circles (McFarlan 1981; Hoper, 1990).

The primary goal of partnering firms engaging in a reciprocal learning alliance

(RLA) is to leverage each others’ knowledge structure in order to develop products or

services that neither one of the partners could develop individually in a competitive

manner. Nevertheless, this is only one aspect of success; RLAs have great potential for

strategic value as they make it possible for firms to jointly develop and leverage

competencies that they could not develop alone (Lubatkin, Florin and Lane’s 2001).

The ability of the outsourcing alliance partners to develop and leverage new

competencies is the second type of positive spillover effects that the company may enjoy.

For years it has been observed by IT consultants ( Tristram, 1998) and CIOs (Dragoon

2004; Cramm, 2006; Levinson 2006) that the success of IT organizations depends on

their ability to market their services to the rest of the company. The process of partnering

between the IT organization and the vendor for the development and marketing of new IT

service offers a unique learning environment for the IT organization. One in which the

IT organization develops a competency that might not have been able to develop on its

own. The IT organization can leverages this new knowledge to promote its services to

the parent company The experience that the alliance offers could be helpful and generate

the good will which is so important for creating a close relationship between the IT

organization and the parent company. The ability of the IT organization to develop and

31

leverage this new knowledge will depend on its relative absorptive capacity (Lubatkin,

Florin and Lane’s 2001). Thus, we propose:

P5a: The synergy in the outsourcing alliance leads to the development of new

competencies that partners could not develop alone.

P5b: The ability of the IT organization to exploit these new competencies

internally increases with the organization’s absorptive capacity.

4.4. Overall Outsourcing Alliance Value Creation Framework

The outsourcing alliance framework – summarized in Appendix B - offers a

strategic alternative, a wider spectrum of possibilities, to IT capable companies.

Traditionally, outsourcing success, even for the so-called strategic alliances or strategic

partnerships, has been defined in terms of the ability of the vendor to satisfy the

requirements of the client. Obviously, while this is an important element for the client it

is, nevertheless, a myopic one, especially for IT capable companies. In the context of the

outsourcing alliance framework, this means that the client participates and exploits only a

fraction of the potential rents. The outsourcing alliance framework, proposes that senior

managers take a more holistic approach and evaluate the collaboration as well as the

transaction-specific potential sources of revenue in their decision making process.

In the following, section we will discuss the implications of the proposed

outsourcing alliance framework for managers and researchers.

32

5. IMPLICATIONS

The proposed outsourcing alliance value creation framework constitutes a

significant deviation from the traditional approach to IT outsourcing, and as a result it is

likely to encounter either skepticism or enthusiasm from IT and non-IT managers.

However, we see the repeat of the Cathay’s approach in many other examples. A similar

story has been with EDS and Continental Airline’s System One. EDS recognized that the

on-line reservation system could be used to attract clients outside the airline industry such

as car-rentals and hotels (Dibbern et al. 2004). The normative aspect of this study offers

the option of an outsourcing alliance as a reasonable alternative, to such arm’s-length

outsourcing deals, for IT capable companies. However, this option requires considering

outsourcing alliance as a strategic option and not an ad hoc solution during periods of

financial pressure.

A key to the acceptance of outsourcing alliances is visioning IT organizations as

revenue centers. While this requires adjustment in the traditional thinking in which IT

organizations are considered cost centers, a significant percent of companies have their

IT organizations generate revenue. Every year, Information Week compiles a list of the

most innovative companies (users) in the area of IT. While the list does not explicitly

relate IT innovation to our definition of IT capability, it is reasonable to assume that these

companies are more likely to have developed their IT capability. A glimpse at the

practices of these companies would serve as an indicator of what would have been the

attitude of IT capable companies towards the notion of seeing IT organizations as

revenue centers. Among the Information Week 500 surveyed companies, as high as 40%

of them report that their IT organizations generate revenues through sales of products or

33

services.8 Therefore, we can conclude that the idea of an IT organization operating as a

revenue center is not a terra incognita, at least not for IT capable companies.

Carmel and Agarwal (2002) identify four stages of maturation of the offshore

outsourcing market: no outsourcing, experimenting, seeking corporate-wide leverage of

cost efficiencies through outsourcing, and proactively seeing outsourcing as a strategic

imperative. The authors estimate that the majority of the large companies will transition

towards the third and fourth stage. This trend refines the spatial, and defines the

temporal, boundary of our study as an attempt to develop a theoretical framework for

outsourcing alliances for IT capable companies. However, while the justification is

adequate for the academic aspect of this study, we will be remiss if we do not point to the

managerial effects that prompted this study, especially, since they add to its practical

contribution. Support is coming from two sources (Economist, and McKinsey) and two

directions (cost and revenues).

The first argument comes from an editorial in the Economist (April 23-29, 2005)

on the issue of strategic management. The author of the article calls the companies to

shift their strategic focus from cost cutting to business building. After the collapse of the

dot com bubble most companies focused on cost cutting and outsourced business

processes to vendors who could operate at a lower per unit cost. This approach delivered

the desired results at the time. However, ‘many companies seem to have become so

hooked on cost-cutting that a sort of anorexia has set in.’9 The editor is concerned with

this approach because cost cutting, while a good approach to improve the bottom line in

the short term, is not a long term solution. 8 Source: Information Week 500 for years 2002, 2003 and 2004. 9 Economist, April 23-29, 2005, p. 14.

34

A similar argument, though from the revenue side, was raised in the recent report

of the McKinsey on Strategy (Smit et al. 2005). The study followed a cross industry

sample of over one hundred large companies over the two most recent business cycles in

order to explore the challenges of revenue growth. The authors found that while cost

improvement can drive earnings and shareholder value in the short term, companies that

raise their shareholders value without increasing their revenue had the worst long term

odd of survival.

The two approaches – cost cutting vs. business building – are similar to the two

main choices that the IT capable company will have to consider – arms length

outsourcing vs. outsourcing alliance. As we have seen in our analysis, the potential

benefits of an outsourcing alliance are higher than those of an arms length outsourcing

deal. In the following paragraph, we will try to relate the above positions, Economist

and McKinsey, in the context of the outsourcing alliance framework.

In a typical arms-length outsourcing deal, the initial benefits for the client are

significant and tangible. The benefits are associated with the liquidation of resources

previously associated with the delivery of the IT service. On the other hand during the

early stages the vendor carries the burden and the expenses. Later on, the roles shift and

the vendor will start enjoying the benefits while the client is facing the stream of

expenditures (McFarlan and Nolan 1995). Figure 4, captures the net cash flow (from a

client’s standpoint) with the downward sloping curve called market.

35

On the other hand, in an outsourcing alliance the initial expenditures are high and

may extend over a period of time before the partners start collecting any significant

stream of revenues.10 While some revenues may occur shortly after the formation of an

outsourcing alliance, the incremental revenues will not materialize until the two partners

learn how to interact and to apply their expertise to attract and service third party clients.

This is captured in the upward sloping curve in Figure 4. In a similar fashion as in the

two sources, Economist and McKinsey, we argue that: For IT capable companies the

benefits of an arms-length outsourcing deal might be limited and myopic in nature. On

the other hand, an outsourcing alliance, as a business building solution, offers a more

rewarding and long-term option.

The risk of opportunistic behavior leading to the failure of an outsourcing alliance

is one of the most significant managerial concerns. While the temptation of opportunistic 10 This pattern is not unique to an outsourcing alliance and it should be expected in all alliances (Madhok and Tallman, 1998)

Figure 4 Alliance (Business Building) vs Market (Cost Containment)

36

behavior may appear to be high for both parties in an outsourcing alliance, its opportunity

cost is too high to justify it as a rational approach. Keep in mind that the firm specific

benefits are only a fraction of the total benefits that partners stand to enjoy as a result of

the outsourcing alliance. The transaction and collaboration specific benefits are equal or

more important than the firm specific benefits (Madhok and Tallman 1998). In addition

to this, the outsourcing alliance has a trait that reduces the risk of opportunistic behavior,

namely the fact that risk that each of the alliance members may step into the partner’s

territory is relatively low. We will elaborate on this in the following paragraphs.

The main premise behind the outsourcing alliance framework is that the alliance

is formed between an IT capable company and an outsourcing vendor. In addition to this

the main objective and priority of the IT organization is to provide the desired IT services

to the parent company. Both the IT organization and its parent company would consider

offering, through the outsourcing alliance, the products/services that approach the

commoditization stage.

The outsourcing alliance reinforces the specialization of partners and this means

that the IT organization would continue focusing on the continuous improvement of its IT

capability. This guarantees the high quality of IT services for both the parent company

and the clients of the alliance, as well as a continuous stream of new services that are

likely to be offered through the alliance as they enter the commoditization phase. This

focus is consistent with the mantra of some of the most successful among the IT capable

companies, such as Wal-Mart, will state that they are in the retail business not in the IT

business (Lundberg 2002). Obviously, maintaining such focus posses no threat to the

vendor and increases the long-term potential of the alliance.

37

The high specialization of f the IT organization serves as the safety mechanism

for the vendor too. It is unlikely that the vendor would want to absorb the entire IT

organization especially if the latter is characterized by high asset specificity to the parent

company. Like the IT organization, the vendor is interested in products or services that

approach the commoditization stage. It is only through such IT services that the alliance

can attain its potential through economies of scale and or scope.

However, unlike the IT organization of the parent company, the vendor has an

incentive to bring new IT services to the market sooner than later. If the vendor were to

proceed with such an opportunistic behavior the opportunity cost would be high. The

vendor would risk the client’s commitment and future cooperation. The opportunity cost

would be proportional to the amount of specific resources that the vendor has committed

to the outsourcing alliance. These resources are likely to lose their value if the alliance

were to fail. Since their use is tied to the co-specialized delivery of the services that only

the IT organization could deliver.

Obviously, there are several weaknesses associated with a client’s choice to enter

into an outsourcing deal. On the top of the list is the issue of flexibility, the ease of

exiting a current alliance and replacing it with another vendor or even insourcing

(Venkatraman and Henderson, 1998; Ybarra and Wiersema, 1999). The risk of

opportunistic behavior is high when the client organization is limited to a long-term

alliance with a single vendor. It is likely that the vendor will have little or no incentive to

accommodate unanticipated changes.

Another issue that has been raised in the literature is with regard to governance

inseparability (Argyres and Liebeskind, 1999). The governance of new transactions

38

becomes inseparably linked to governance of transactions that have been previously

contracted for with the vendor. Clients are also concerned about losing the skills that

they outsource (Quinn, 1999). Last but not least, measuring the vendor’s contribution

and monitoring vendor’s activities to ensure alignment with the client’s interests is more

difficult in outsourcing alliances (Kishore et al. 2003). However, these limitations are

inherent in outsourcing and they are not unique in outsourcing alliances. One could

argue that the adverse effect of some of these limitations would be less in outsourcing

alliance as compared to an arms-length outsourcing deal.

6. CONCLUSION

With the commoditization of IT and the inability of many companies to align IT

with their business strategy, executive managers increasingly believe that traditional

arms-length outsourcing is the only viable solution. This paper offers a viable alternative

or a bargaining point for IT capable companies. It argues that through outsourcing

alliances those companies can realize additional quasi rents leading to greater value

addition by their IT organizations.

This study contributes to our knowledge of the IT outsourcing literature in several

areas. According to Dibbern et al. (2004) in spite of the spike in IT outsourcing research,

further research is ‘critically needed’ in order to enhance our knowledge in areas as: the

evolving definition of outsourcing success, the need to define outsourcing success in a

way that accounts for both the client and vendor perspective, and the understanding of the

client vendor relationship.

This paper contributes to the development of a theoretical model of strategic IT

alliance performance by examining the implications for several economic and strategic

39

management theories on that type of collaboration. We have proposed a new definition

of it based on the ways in which strategic management has defined alliance performance.

Our definition stresses the importance of outsourcing success as the common ground of

client and vendor benefits. Finally, the focal point of our research, outsourcing alliances,

is one of emerging phenomena in the outsourcing literature (Dibbern et al. 2004).

The outsourcing alliance framework offers a fertile ground for more theoretical

and empirical research that could try to enhance, improve, and empirically test some of

our proposition. For example;

1. Future studies could try to empirically validate the value-adding proposition of the

outsourcing alliance framework. This could be accomplished with the help of cross-

sectional longitudinal study that could compare the rent generating ability of

outsourcing alliance versus arms-length outsourcing deals.

2. This study considers the outsourcing alliances from the standpoint of the IT capable

companies. A future study might approach the issue from the standpoint of

outsourcing vendors.

3. The model that we have developed does not address the issue of what to outsource.

Additional research/fine tuning will be needed in order to evaluate the conditions

under which an outsourcing alliance may be successful or not once you consider IT

service/products that are associated with core versus support activities.

4. In our discussion we concentrated in transaction costs as determinant of the make-or-

buy decision. However, firm facing similar transaction costs actually makes various

make-or-buy decisions (e.g., Leiblein and Miller 2003).

40

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APPENDIX A

The derivatives for the first equation:

HH

HHHHHHHH

QQts

DQGDQCQDQPVˆ..

)},ˆ(),({*),(max

≤

+−=

where:

0<′HQP , 0>′′

HQP

0>′DP , 0>′′DP

and,

SupporttDevelopmenH CCC +=(.)

)Q|C(D H=tDevelopmenC

0>′DC , 0>′′DC

D)|C(Q H=SupportC

0>′HQC , 0<′′

HQC

)Q D,|C(AS H=yOpportunitC

0<′ASC , 0>′′ASC

The additional derivatives for opportunity cost:

AS) D,,Q̂C( H=HO

0<′ASHO , 0>′′

ASHO

APPENDIX B