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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
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     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
____________________________________________________________________________________

2 A. Indicators of Financial Considerations

The factor analysis (reference A listed in table 2) of the ten indices for financial considerations listed in Table 1 reveals that four factors together explain 68.1 percent of the total variance. They subdivide the observed indicators into only four classes. The first subset includes the indicators associated with return on technology subcategory listed in Table 1 (NIIT and SAIT). The second factor comprises ITGP, ITNP, LDSE and EAPS. The third factor includes the indices composing the business cost structure category (CSSA and CSTA). REOA and TLSE together comprise the fourth factor.

Some reflection shows that the four classes of indicators identified by factor analysis A are more meaningful than the five classes identified on the basis of an earlier study (Loh and Venkatraman, 1992a) and presented in Table 1. While the first and third factors represent the subcategories of return on technology and business cost structure, the indices LDSE and EAPS are combined with indices for technology cost structure to constitute the second factor. This may be explained by the link between financing of IT investments with long-term debt and the resulting effect on earnings per share. Thus, the second factor represents the long-term effect of IT investments on financial performance. The fourth factor comprising REOA and TLSE explains the link between increased total liabilities and corresponding decrease in return on assets [due to investments in IT], and hence represents the 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.