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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)

A_i = Parameters that are assumed to have specific values

B_i = 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, 1994. 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 1994). 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 1994). 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 1993-94. 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 1994).