CRITICAL SUCCESS FACTORS OF OFFSHORE SOFTWARE DEVELOPMENT PROJECTS

Index

Agency Theory
Transaction Cost Theory
Power and Politics Theories
Relationship Theories
Social Exchange Theory
Resource Theories
Strategic Management Theories

The field of IT outsourcing (in a broad sense) can be traced back to numerous theories, all of which may prove to be useful when identifying which IT activities shall be outsourced and determining how the outsourcing arrangement shall be coordinated and managed most efficiently. In the process of compiling these reference theories in their research, Dibbern et al. (2004) adapted the structuring approach of Kim and Lee (1999), hereby combining the different theories into three distinct categories.

·        Economic theories concentrate on the coordination and the regulation of economic agents or units in regard to their transactions with one another. Reference theories in this context include the agency theory and the popular transaction cost theory.

·        Social theories focus on different types of relationships that exist between individuals, groups, and organizations, thereby encompassing theoretical foundations such as power and politics theories, relationship theories, and the social exchange theory.

·        Strategic theories deal with a company’s approach to developing and implementing strategies and include the resource-based theory, the resource dependency theory, as well as strategic management theories.

The following table gives an overview of the individual theories, thereby pointing out their basic assumptions, specific focus, as well as supporting literature (Dibbern et al., 2004).

Table: Overview of theoretical foundations

The theoretical concepts listed above will each be briefly introduced in the following sections.

Beside the already mentioned theories concerning IT outsourcing in general, the concepts of IT offshoring and OSD can originally be traced back to Ricardo’s theory of comparative advantage. According to this theory, even if a country could produce everything more efficient than another country, it would benefit from specializing in what it was best at producing and trading with other nations (Ricardo, 1821).

Ricardo’s theory also forms the basis of modern trade theory, reformulated as the Heckscher-Ohlin theorem. This theorem states that a country possesses a comparative advantage in the production of a product if it is relatively well-endowed with the factors of production which are used intensively in producing this product (Case and Fair, 1999).

According to Dibbern et al. (2004), both the agency theory and the transaction cost theory represent economic theories. Agency theory is based on the concept that a company represents a conjunction of contracts between principals or stakeholders and agents.

The basic assumption of agency theory is the existence of asymmetric information and a different degree of risk perception between principal and agent as well as uncertainty. Here, the basic line of reasoning suggests that the principal hands over specific decision rights to the agent and, at the same time, sets incentives in order to ensure that the agent’s actions are in line with the principal’s interest. In this context, the dimension of such incentives depends significantly on the anticipated costs of controlling the agent (Dibbern et al., 2004). An example of agency theory used in the field of IT outsourcing is given by Hackney and Hancox (1999, p. 5), who suggest: “…the focus of AT [agency theory] is not the decision to source via the hierarchy or via the market (…). AT in short, helps to expose problems of divergent interests within both markets and hierarchies.” However, in response, Dibbern et al. (2004) point out the lack of attention attributed to the potential for adverse outcomes, as a result of wrong decisions.

When deciding which IT activities shall be outsourced, transaction cost theory, introduced by Coase (1937), is among the most frequently mentioned theoretical foundations. Primarily developed by Williamson (1975, 1981, 1985), the theory, also referred to as transaction cost economics, suggests that, as a result of a costly market, economic efficiency can only be achieved by means of a comparative analysis of production and transaction costs. Further, the theory assumes both limited rationality and opportunistic behavior from all the relevant parties (Simon, 1957). In consequence, the parties take advantage of opportunities at the expense of others (Williamson, 1981). Here, however, it must be noted that the negative consequences of opportunistic behavior are more likely to emerge in market coordination than within a company, as there, they can be prevented by hierarchy structures.

In a more detailed fashion, Schwarz (2005a) projects the four types of transaction costs onto the field of IT outsourcing:

·        Search costs: For identifying and evaluating potential partners.

·        Contract costs: Associated with the negotiation and writing of an agreement with the outsourcing provider.

·        Monitoring costs: Ensuring that all parties fulfill their contractual obligations.

·        Modification costs: Resulting from either changes in performance on the part of the provider or changes in regard to external conditions.

Transaction cost theory has often been used for research in the field of IS in an attempt to explain the impact of IT on the boundaries of a company (Huang and Yang, 2000). According to Bryson and Ngwenyama (1999), it provides a set of principles for analyzing buyer-supplier transactions and identifying the most efficient way of structuring and managing them. This idea, when projected on the field of IT outsourcing, could, for instance, reflect the transactions between the outsourcing company and the provider.

Power and politics theories represent an example of the social theories examined by Dibbern et al. (2004). As opposed to Emerson’s (1972) perception of power in regard to individuals in a social exchange, Pfeffer (1981) assumes that power as well as idiosyncratic interests and politics take on major roles in an organization’s decision-making process. In this context, power is often defined as the basic energy to initiate and sustain actions, in order to translate intentions into reality (Dibbern et al., 2004).

According to de Looff (1997), power and politics can influence a decision-making process in the field of IT outsourcing in three different ways: In the decision process itself, in the examination of the expected distribution of power, as well as in the design and the management of the outsourcing agreement.

During the actual decision-making process, decision makers may embrace other objectives than the best interest of their department or organization, and, therefore, turn to rely on other tactics aside from plain arguments or research results. In this context, Hirschheim and Lacity (1993) found that some IT managers used political tactics, such as the requesting of bids from expensive suppliers, to underline the efficiency of their department towards top management. In addition, Hirschheim and Lacity (1993) identified some IT department as the least powerful departments in their respective organizations, with the IT manager ranking up to three levels below the company’s CEO. Senior managers often label IT functions as cost burdens and regard them as value-consuming. Their perceptions combined with the lack of power on the part of the IT departments many a time result in restrictive IT investments (de Looff, 1997).

De Looff (1997) further emphasizes the need for decision makers to analyze the expected distribution of power between the client organization and possible suppliers, when considering outsourcing as a perceived unbalanced distribution that may represent a key argument for not engaging in outsourcing activities. One particular source of power on the part of the client organization in this context could be the client’s decision regarding which IT activities to award to a specific supplier or whether or not to offer follow-up contracts.

In regard to existing IT outsourcing relationships, de Looff (1997) dwells on the need for the client organization to ensure a constant balance of power between themselves and their supplier. In an attempt to design such a relationship, the client may, for instance, split the project into phases, only awarding the first phase to the supplier, or postpone a percentage of the payments for a development project until the system has proven to be error-free.

Closely related to the social exchange theory, yet more complex and tangible, relationship theories regard cooperation, interactions, as well as social and economic exchanges as pivotal factors in interorganizational relationships. Due to their focus on the interactions between parties that are specifically geared towards the joint accomplishment of the individual party’s objectives, relationship theories are often linked to strategic management or topics such as alliances, competitive advantages, and supplier-buyer relationships (Dibbern et al., 2004). Klepper (1995) and Kern (1997a) further point out that the parties to an exchange agree that the outcomes of the exchange are greater than those that could be achieved through alternate forms of exchange or from exchange with a different partner. This mutual agreement serves as a kind of motivation for the parties to consider the relationship important, hereby offering to devote resources towards its maintenance and development (Dibbern et al., 2004).

Social exchange theory, according to Homans (1961), centers on the exchange of activities between two or more people. In this context, the relevant activities may be tangible or intangible as well as rewarding or costly.

Blau (1964) defines social exchange as “voluntary actions of individuals that are motivated by the returns they are expected to bring and typically do in fact bring from others” (p. 91). Based on Emerson’s (1972) research, the attributes reciprocity, balance, cohesion, and power are pivotal in an exchange. While reciprocating the benefits received helps to reinforce the attributes of an exchange, balance refers to the individual degree of dependency the actors possess on their counterparts in the exchange. Further, cohesion takes place when one or both actors in the exchange encounter conflict in regard to the exchange (Dibbern et al., 2004). Finally, Emerson (1972) defines power as the level of cost one actor can bring about over the other.

In regard to strategic theories, Dibbern et al. (2004) examine resource theories as well as strategic management theories. Resource theories can be either resource-based or resource-dependent. Both of them view a firm’s resources as the sole foundation for the implementation of the company’s strategy. While resource-based theory emphasizes a firm’s internal resources, resource-dependency theory focuses on various resources in the company’s external environment. In regard to resource-based theory, Barney (1991) and Penrose (1959) argue that a firm can only gain competitive advantage, if heterogeneity and immobility of the firm’s resources exists. In contrast, from a resource-dependant perspective, Pfeffer and Salancik (1978) point out that all organizations are, in varying degrees, dependant on at least some of the elements of their specific external environments, due to the control these environments have on their resources.

Theories explaining the strategic activities of a particular company are referred to as strategic management theories. While numerous definitions of strategy can be found in literature, Chandler (1962) defines strategy as the determinant of the basic long-term goals of an enterprise, as well as the adoption of courses of action and the allocation of resources necessary for carrying out these goals. A well known example for strategic management theory is Porter’s (1985) theory of strategic advantage, in particular his five forces model.

References