A Conceptual Framework and Empirical Analysis

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Copyright, 1995, Yogesh
Malhotra, Ph.D., @BRINT Institute, All Rights Reserved

E-Mail: malhotra@brint.com

Malhotra, Yogesh. "IS Productivity And Outsourcing Policy: A Conceptual Framework and Empirical Analysis," in theProceedings of Inaugural Americas Conference on Information Systems(Managerial Papers), Association for Information Systems, Pittsburgh, Pennsylvania, August 25-27, 1995, pp. 142-144.

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A Conceptual Framework and Empirical Analysis

IS outsourcing policies define the criteria that organizations utilize to decide upon the scope and degree of reliance of their IS capabilities upon external sources. Financial considerations and business strategy are the two major determinants of the IS outsourcing decision. Most controversy on outsourcing of IS has been around the issue of increasing performance - generally by reducing costs and improving service. In this context, the study of the interrelationships between IS outsourcing policy, the business and financial strategy considerations and IS productivity, is increasingly relevant for providing a more balanced perspective to the ongoing debate.

This paper proposes an integrative conceptual framework for analyzing the above relationships. A structural equation model was created to represent the proposed conceptual framework. The model was operationalized by using factor analysis and stepwise regression analyses. Since the objective of the study was to investigate the influence of financial criteria and business strategy variables on IS performance, the set of companies selected as "the 100 most effective users of information technology" by Computerworld Premier 100 survey (1994) represents an acceptable sample. Data integrity was ensured by extracting all remaining data from the same public sources as those used by the survey. The study has important implications for the new measure of IS productivity, as well as the continued emphasis on primarily macro-level financial measures for determining the effectiveness of IS.

The proposed conceptual framework has two 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. The first objective is characterized by:

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 is represented by:

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." The two objectives are integrated in the model delineated in Figure 1.

The endogenous and exogenous variables, and their corresponding indices, of the conceptual model are listed in Table 1.

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 VARIABLESIS 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 DepartmentIS Productivity (ISP)Return from investments in IS. IPI (Information Productivity Index)EXOGENOUS VARIABLESFinancial Considerations (F)Financial conditions of the company that may affect allocation of capital and cost-cutting measures for different functions.Business cost structureCSSA (Cost of Goods Sold+Selling, General & Administrative Expenses)/Sales CSTA (Cost of Goods Sold+Selling, General & Administrative Expenses)/Total AssetsFinancial leverageLDSE Long-term Debt/Shareholders' Equity TLSE Total Liabilities/Shareholders' Equity Business performance REOA Return on Assets EAPS Earnings Per Share ($)Technology cost structureITGP IT Expenditure/Gross Plant, Property & Equipment ITNP IT Expenditure/Net Plant, Property & Equipment Return on Technology NIIT Net Income/IT Expenditure SAIT Sales/IT ExpenditureBusiness Strategy (B)Strategic significance of the IS function in the company.Relative Importance of ISISBDGT IS Budget as % of Revenue BDGTCHG Growth in IS Budget (% over last 5 years) ISPEMP Total Number of IS Staff/Total Number of EmployeesStrategic Position of IS within firmTOCEO 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) ____________________________________________________________________________________

ISOUT represents IS Outsourcing Policy (OP) - higher ISOUT implies lesser reliance on internal IS department and greater reliance on external sources: both inside as well as outside the organization. IS Productivity is measured by the "Information Productivity Index" (or IPI) as presented in the table of Computerworld Premier 100. IPI, which has been described as a better measure of IS productivity than more traditional measures, is expected to represent the return on management of IS (Strassmann 1990,1994).

The structural model is based upon the equations (1) and (2) defined before.

ISP = B0 + B1*F + B2*OP (3b)

OP = Outsourcing Policy (Endogenous Explanatory)

ISP = IS Performance (Endogenous)

F = Financial Considerations (Exogenous) B = Business Strategy (Exogenous)

Ai = Parameters that are assumed to have specific values

Bi = Parameters that are assumed to have specific values.

Factor analyses was used to determine the underlying dimensions of exogenous variables F and B. Table 2 exhibits the summary of data and indices obtained from the factor analysis done for determining the underlying indices.

Table 2. Data and Indices Obtained by Factor Analysis___________________________________________________________________________________ Factor Analyses -------------------------------------------------------------- Data Reference Index ____________________________________________________________________________________ Financial Considerations(F) Return on Technology A Performance index NIIT SAIT Technology cost structure ITGP ITNP LDSE EAPS A Long-term index Business cost structure A Business cost index CSSA CSTA REOA TLSE A Short-term index Business Strategy(B) Strategic Position of IS B Position index TOCEO TOCFO Relative Importance of IS B Competitive index ISBDGT BDGTCHG ISPEMP ____________________________________________________________________________________

Factor analysis (Reference A) of the ten indices for Financial Considerations listed in Table 1 reveals that four factors together explain 68.1 percent of the total variance. While the first and third factors represent the subcategories of return on technology and business cost structure, the second factor represents the longterm effect of IT investments on financial performance, and the fourth factor 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.

Factor analysis (Reference B) of the five Business Strategy indicators supports their categorization into the two classes that were based on intuition.

Two stage least squares method was used to determine the parameters of the structural equations. Ordinary stepwise regression was done on the equations of the reduced model. Parameters from this regression were then used to derive the estimated values (EISOUT) of the endogenous explanatory variable (ISOUT index of the OP variable). The estimated values were used for the next stepwise regression to determine the parameters of the structural equation (3b) for the other endogenous (non-explanatory) variable.

Tables 3 and 4 depict the results of the two regression analyses. In both cases, the F-value suggests that the regression is significant at .01 significance level. The R-square values indicates that in both regressions over twelve percent variance is explained by the explanatory variables.

Table 3: Determinants of IS Outsourcing (ISOUT)____________________________________________________________________________________ Explained Variable _______________________________________ Explanatory Variables a,b,c % IS Budget Spent Outside IS Department ____________________________________________________________________________________ R-Square .1421 F valuec [2,72] 5.96 Sig F .004 Constant 138.93 A. Financial Considerations Performance 91.23 (1) Business cost -77.50 (2) ____________________________________________________________________________________ a Only the explanatory variables selected by stepwise method up to the 0.05 level of significance are included in this table b For each variable, data are values of the regression coefficients; numbers in parentheses indicate step when entered into the corresponding regression. c Values in brackets are corresponding degrees of freedom for F coefficient of the equation.

____________________________________________________________________________________ Explained Variable _______________________________________ Explanatory Variables a b Information Productivity Index ____________________________________________________________________________________ R-Square .1210 F valuec [2,81] 5.574 Sig F .005 Constant .2775 A. Financial Considerations Business cost -.068086 (1) Short-term -.056296 (2) ____________________________________________________________________________________ a b c Same as for Table 3 Table 4: Determinants of IS Productivity (IPI)

Results in Tables 3 & 4 suggest the relative importance of Financial Considerations in determining the IS Outsourcing Policy and the firm's IS Productivity. Of the Financial Considerations, performance seems to positively influence the IS outsourcing decisions, while higher business cost structure has a negative effect. Business Strategy considerations do not seem to influence IS Outsourcing Policy. Further, IS Outsourcing Policy does not seem to have any direct influence on IS Productivity. However, these results could have been influenced by the limitations inherent in this kind of study.

The results of the study are interesting in several respects. First, based on the results, it can be argued that the new measure of IS performance used by Computerworld, although intended to give due emphasis to management of IS, hasn't adequately addressed its objective. Second, inconsequential significance of the Business Strategy indices could be attributed the indirect influence of IS investment on the organizational IS performance measures such as IPI. One approach for overcoming this limitation could involve using mediating variables that could represent process-level or function-level contribution of the IS function. A second approach could involve comparison of the market value of the IS function with alternative [internal or external] options available to the organization. Further research in IS outsourcing can reveal more reliable and valid findings by taking into consideration the findings of this study and the limitations mentioned herein.

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