Managing Successful IT Outsourcing Relationships docx

i
Managing Successful
IT Outsourcing
Relationships
Petter Gottschalk
Norwegian School of Management, Norway
Hans Solli-Sæther
Norwegian School of Management, Norway
IRM Press
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Library of Congress Cataloging-in-Publication Data
Gottschalk, Petter, 1950-
Managing successful it outsourcing relationships / Petter Gottschalk and Hans Solli-Saether.
p. cm.
Summary: “This book focuses on the important issues of strategy, structure, and management of IT
outsourcing relationships” Provided by publisher.
Includes bibliographical references and index.
ISBN 1-59140-760-5 (hc) ISBN 1-59140-761-3 (sc) ISBN 1-59140-762-1 (ebook)
1. Information technology Management. 2. Contracting out. 3. Electronic data processing depart-
ments Contracting out. I. Solli-Saether, Hans. II. Title.
HD30.2.G676 2006
658.4'058 dc22
2005013819
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All work contributed to this book is new, previously-unpublished material. The views expressed in this
book are those of the authors, but not necessarily of the publisher.

iii
Managing Successful IT
Outsourcing Relationships
Table of Contents
Foreword vii
Preface ix
Chapter I. Introduction 1
Three International-Based Research Case Studies 4
Chapter II. IT Outsourcing 6
Transformational Outsourcing 7
Outsourcing Decisions 10
IT Outsourcing Markets 10
Business Application Outsourcing 12
Business Process Outsourcing 14
Maturity 15
Innovation Diffusion 18
Outsourcing Definitions 19
Business Example: Offshore Insurance Business Process
Outsourcing 24
Business Example: Ministry of Children and Family Affairs 25
Case Study: Total Outsourcing Keeping a Strong In-house
Group 26
Chapter III. Some Fundamental Perspectives 28
Value Configurations 28
E-Business Infrastructure 38
Vendor Value Proposition 52
IT Function Organization 57
Outsourcing Performance 58
Successful Relationships 60
iv

Outsourcing Opportunities 60
Outsourcing Threats 62
Business Example: NetCom 68
Business Example: DuPont 69
Case Study: The Largest Buy-Out in Europe 70
Chapter IV. IT Outsourcing Theories 71
Transaction Cost Theory 71
Neoclassical Economic Theory 77
Contractual Theory 78
Theory of Core Competencies 85
Agency Theory 89
Resource-Based Theory 91
Partnership and Alliance Theory 105
Relational Exchange Theory 108
Stakeholder Theory 112
Theory of Firm Boundaries 114
Social Exchange Theory 117
Comparison of Theories 120
Business Example: British Aerospace 120
Business Example: North Cape Minerals 124
Case Study: A Global Deal 125
Chapter V. Enter Strategy 127
Distinctive IT Nature 127
Sourcing Alternatives 129
Global Outsourcing 136
Strategic IT Planning 140
Project Management 147
Conclusions 152
Case Studies: Enter Strategies 152
Chapter VI. Phases and Activities 155

Phase 1: Vision 155
Phase 2: Evaluation 156
Phase 3: Negotiation 157
Phase 4: Transition 158
Phase 5: Improvement 159
v
Phase 6: Mature 162
Winner’s Curse 163
Conclusions 164
Case Studies: Relationship Phases 164
Chapter VII. Contract Development 168
Contract Structure 168
Asset Transfer 170
Risk Sharing 171
Technology Upgrading 172
Contract Duration 173
Due Diligence 174
Outsourcing Relationships 175
Relationship Management 176
Fee Arrangements 177
Dispute Resolution 178
Public Sector 180
Conclusions 180
Case Studies: Contract Development and Management 181
Chapter VIII. Personnel Issues 184
Reduction in IT Staff 184
Employment Protection 185
Pension Considerations 186
Predictors of Persistent Stakeholder Expectations 187
Persistence in Managerial Expectations 195

Transplant Perception of Role 201
Conclusions 202
Case Studies: Transfer of IT Employees 203
Chapter IX. Governance Structures 205
Perspectives on Governance 205
Interaction Approach 212
Management Control Systems 215
Performance Measurement 218
Partnering Relationships 222
Partnership Quality 223
Stakeholders 227
vi
Hard and Soft Sides 228
The IT Outsourcing Governance Model 230
Conclusions 235
Case Studies: Governance Structures 236
Chapter X. Costs, Benefits, and Risks 239
Production and Transaction Economies 239
Hidden Costs 244
Contract Termination Costs 246
Benefits 247
Strategic Risk Behavior 249
Conclusions 251
Case Studies: Outsourcing Costs 252
Chapter XI. Knowledge Management 254
Intellectual Capital Management 254
Vendor Value Proposition 258
Business Process Management 259
Knowledge Management Technology 260
Stages of Technology Growth 263

Conclusions 269
Case Studies: Retained Skills 269
Chapter XII. Exit Strategy 271
Think Exit 271
Strategic Outsourcing Termination 273
Contract Termination 274
Exit Management 276
Project Management 278
Conclusions 281
Case Studies: Exit Strategy 282
Conclusions 283
References 286
About the Authors 298
Index 299
vii
Foreword
In this well-timed book Petter Gottschalk and Hans Solli-Sæther methodically tackle the
subject of IT outsourcing and how to successfully manage outsourcing relationships,
something that is crucial for the success of any organization. In doing so, they bring
together their expertise as academics and researchers, along with Professor Gottschalk’s
enormous wealth of experience as one-time chief information officer and chief executive
officer of several organizations.
From the humble beginnings of a quarter century ago, IT outsourcing has today be-
come a vast, half-trillion-dollar global industry. Gone are the days of ongoing debate on
whether to outsource IT. Today it is an acceptable fact that one just cannot buck the
tide of outsourcing.
Outsourcing of IT covers a range from communications network management, hard-
ware/software maintenance, application management, IS management, business pro-
cess outsourcing, and so forth. It represents a substantial segment of overall IT spend-
ing. Yet not many executives are quite clear about the various aspects of IT outsourcing

and therefore run the risk of missing out on certain business opportunities.
Recent research by Gartner has revealed that satisfaction among chief information
officers over their outsourcing contracts has dropped over the past few years. It is
primarily because they fail to understand that what, where, when, and how to outsource,
and how to manage outsourcing contracts is one of the most demanding, vital, and
essential business skills needed for a company’s success. Customers and suppliers are
still failing to grasp what makes for a good outsourcing relationship.
This book answers the entire range of above questions in a lucid yet exhaustive way. It
covers all aspects of outsourcing and its opportunities and threats. For practitioners, it
describes the phases of outsourcing, details of contract development, governance
structures, costs and personnel issues, and outsourcing challenges. Further, it adds
academic rigor to its arguments by dealing with theoretical aspects of outsourcing
such as resource-based theory and value configurations to outline how a firm can use
outsourcing to bring about fundamental strategic changes rather than just cutting
costs and improving organizational focus.
Inclusion of chapters on entry and exit strategies is notable, and will help the readers
develop trust and good governance in their outsourcing relationships. A number of
case studies are included to provide additional help to the reader better understand the
subject matter, and relate it to real-world scenarios.
viii
All in all, this book is a most comprehensive guide on all aspects of IT outsourcing, and
is highly recommended for practitioners, researchers, policy makers, and consultants
alike.
Vijay Khandelwal
Sydney, Australia
ix
Preface
The market for information technology (IT) outsourcing services is growing rapidly,
and costs associated with external IT services are rising in most business and public
organizations. The reliance on outsourcing as a means of providing IT services has

been growing steadily over the past decade. IT outsourcing decisions are important
because their resolution involves significant organizational and institutional implica-
tions. An urgent need for strategy and management of outsourcing has emerged.
IT outsourcing is the practice of turning over all or part of an organization’s IT to an
outside vendor. Though IT may never have been more critical to business success, IT
outsourcing is developing at an unprecedented rate.
Even though the IT outsourcing market has grown tremendously over the past years,
many organizations do not have a reflective understanding of the complex process of
IT outsourcing. The process does affect both technological and business goals and
activities, and companies must establish both strategies and structures adjusted to
their degree of outsourcing. Several critical success factors arise, and they touch upon
the relationship with internal and external stakeholders.
The overall objective of this book is focus on the important issues of strategy, struc-
ture, and management of IT outsourcing relationships. Using well-known theoretical
perspectives and experiences earned from several business cases, our mission is to
develop models and guidelines for the complex IT outsourcing process and emerging
relationships.
The intended audience of this book includes undergraduate and graduate students, as
well as practitioners, both on the customer and vendor sides. Undergraduate students
in management IS will learn how future IT organizations will be restructured from a
resource-based perspective. Graduate students will learn how strategy will shape fu-
ture sourcing, and how management roles change as sourcing strategies evolve. Ven-
dors will appreciate insights into value propositions, formal agreements, and relation-
ships from this book. Customers will appreciate insights into strategic choices and
relationship management from this book.
Even though IT outsourcing is a practical issue, it also has significant impact on busi-
ness organization theories. IT outsourcing as a discipline is based on several other
concepts and disciplines, as well as the relations between them—international busi-
ness, marketing, psychology, technology management, strategic management, project
management, knowledge management, finance, economy, organizations, traditional

x
management, political science, and behavioral sciences. For example, transaction cost
theory is an important element in the outsourcing decision-making process. Resource-
based theory of the firm, including the knowledge-based perspective of the firm, is
another example of important scholarly value, when applied to IT outsourcing models.
Bringing well-known theoretical contributions together with our own business experi-
ence, prior research from related fields, and new case studies of IT outsourcing, the
models and guidelines presented in this book will be a synthesis for effective learning.
Petter Gottschalk and Hans Solli-Sæther
Oslo, Norway, October 2004
Introduction 1
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permission of Idea Group Inc. is prohibited.
Chapter I
Introduction
Information technology (IT) outsourcing—the practice of transferring IT assets, leases,
staff, and management responsibility for delivery of services from internal IT functions
to third-party vendors—has become an undeniable trend ever since Kodak’s 1989
landmark decision. In recent years, private and public sector organizations worldwide
have outsourced significant portions of their IT functions, among them British Aero-
space, British Petroleum, Canadian Post Office, Chase Manhattan Bank, Continental
Airlines, Continental Bank, First City, General Dynamics, Inland Revenue, JP Morgan,
Kodak, Lufthansa, McDonnell Douglas, South Australian Government, Swiss Bank,
Xerox, and Commonwealth Bank of Australia (Hirschheim & Lacity, 2000).
How should firms organize their enterprise-wide activities related to the acquisition,
deployment, and management of information technology? During the 1980s, IT profes-
sionals devoted considerable attention to this issue, primarily debating the virtues of
centralized, decentralized, and federal modes of governance. Throughout the 1980s and
1990s, IT researchers anticipated and followed these debates, eventually reaching
considerable consensus regarding the influence of different contingency factors on an

enterprise’s choice of a particular governance mode (Sambamurthy & Zmud, 2000).
Today, however, there are increasing signs that this accumulated wisdom might be
inadequate in shaping appropriate insights for contemporary practice. The traditional
governance logic has been turned upside down by utilizing other mechanisms, such as
sourcing arrangements, strategic alliances, roles, teams, processes, and informal rela-
tionships, as the primary vehicles through which business executives orchestrate their
IT organizational architectures.
Today’s IT organization must grapple with the unrelenting challenges associated with
acquiring current technical knowledge; attracting, retaining, motivating, and leveraging
an IT workforce; distilling the confusion amid a proliferation in IT products, services, and
vendors; and contracting and managing a variety of relationships involved with selective
2 Gottschalk & Solli-Sæther
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permission of Idea Group Inc. is prohibited.
outsourcing. Increasingly, the providers of IT products and services are being viewed
as both arms-length suppliers of cost-effective technology and as vibrant business
partners with an unlimited potential to enhance a firm’s IT and business capabilities. IT
procurement has moved from being operational to tactical to strategic, amidst networks
of alliances with IT vendors, consultants, and third-party service providers being built
and managed in order to leverage their associated assets, competencies, and knowledge.
As the outsourcing market evolves, a number of important aspects of IT outsourcing
decisions have been explored. These studies can be categorized as descriptive case
studies and surveys of the current outsourcing practices, surveys of practitioners’
perceptions of risks and benefits of outsourcing, and identification of best practices that
distinguish success from failure (Hirschheim & Lacity, 2000). We will present many of
these studies in this book.
In general, the current research indicates that selective sourcing is still the norm but that
outsourcing options are becoming more complex. There are many perceived benefits and
risks of outsourcing, but these studies are based on respondents’ perceptions rather
than actual outcomes. The determinants of outsourcing research generally show that

companies most likely to outsource on a large scale are in poor financial situations, have
poor IT functions, or have IT functions with little status within their organizations. There
is still considerable debate on best practices that distinguish successes from failures.
Outsourcing has become popular because some organizations perceive it as providing
more value than an in-house computer center or information systems (IS) staff. The
provider of outsourcing services benefits from economies of scale and complementary
core competencies that would be difficult for a firm that does not specialize in information
technology services to replicate. The vendor’s specialized knowledge and skills can be
shared with many different customers, and the experience of working with so many IS
projects further enhances the vendor’s expertise. Outsourcing allows a company with
fluctuating needs for computer processing to pay for only what it uses rather than to build
its own computer center, which would be underutilized when there is no peak load. Some
firms outsource because their internal IS staff cannot keep pace with technological
change or innovative business practices or because they want to free up scarce and
costly talent for activities with higher paybacks (Laudon & Laudon, 2005).
Not all organizations benefit from outsourcing, and the disadvantages of outsourcing
can create serious problems for organizations if they are not well understood and
managed. Many firms underestimate costs for identifying and evaluating vendors of IT
services, for transitioning to a new vendor, and for monitoring vendors to ensure that
they are fulfilling their contractual obligations. These hidden costs can easily undercut
anticipated benefits of outsourcing. When a firm allocates the responsibility for devel-
oping and operating its IS to another organization, it can lose control over its IS function.
If the organization lacks the expertise to negotiate a sound contract, the firm’s depen-
dency on the vendor could result in high costs or loss of control over technological
direction. Firms should be especially cautious when using an outsourcer to develop or
to operate applications that give it some type of competitive advantage. A firm is most
likely to benefit from outsourcing if it understands exactly how the outsourcing vendor
will provide value and can manage the vendor relationship.
This book consists of two parts. The first part, chapters I–IV, provides background
material to understand and analyze the phenomenon of IT outsourcing. This part covers

Introduction 3
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permission of Idea Group Inc. is prohibited.
topics such as outsourcing definitions (Chapter II), opportunities and threats, value
configurations, e-business infrastructure (Chapter III), and IT outsourcing theories
(Chapter IV). The second part presents key topics in managing successful IT outsourcing
relationships, as illustrated in the Figure 1.1. Managing successful IT outsourcing
relationships starts with an enter strategy and ends with an exit strategy. Foundations
for success are phases and activities (vision, evaluation, negotiation, transition, im-
provement, and performance) as well as contract development (contract structure, asset
transfer, risk sharing, technology upgrading, contract duration, relationship manage-
ment, fee arrangements, and dispute resolution). Chapters VI and VII serve as input to
the management of outsourcing relationships, which consist of the four elements:
personnel issues, governance structures, costs, and knowledge management.
In an outsourcing relationship, the vendor and the client need to transfer, exchange, and
develop knowledge on a continuous basis. All services delivered, received, and evalu-
ated are based on an exchange of knowledge between vendor personnel and client
personnel. If this knowledge exchange is poorly structured or completely unstructured,
then misunderstandings leading to poor service quality will occur. On the other hand,
if vendor and client both have installed modern knowledge management, then service
delivery and improvement will be both efficient and effective. The importance of
knowledge exchange in managing successful IT outsourcing relationships has led us to
include a whole chapter on knowledge management at the end of this book. The
importance of this chapter on knowledge management will also be evident as we discuss
the vendor value proposition. The vendor value proposition may consist of complemen-
tary competencies such as personnel development, methodology development, and
client relationship management. Knowledge management is a key enabler of growing
complementarities and expanding competencies.
Figure 1.1. Key topics of managing successful IT outsourcing relationships

Chapter VII
PERSONNEL ISSUES

Chapter IX
COSTS

Chapter VIII
GOVERNANCE STRUCTURE
S

Chapter X
KNOWLEDGE MANAGEMENT


Chapter V
PHASES AND ACTIVITIES

Chapter VI
CONTRACT DEVELOPMENT


Chapter IV
ENTER STRATEGY

Chapter XI
EXIT STRATEGY

4 Gottschalk & Solli-Sæther
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permission of Idea Group Inc. is prohibited.

Using well-known theoretical perspectives and experience gained from several business
cases, our mission is to develop models and guidelines for the complex IT outsourcing
process and emerging relationships. This is done throughout the book. To highlight our
recommendations, we end Chapters V to XII with a conclusions section, where we express
our own opinions for managing successful IT outsourcing relationships.
Three International-Based
Research Case Studies
In order to understand the inherent complexities and the underlying constructs of
managing successful IT outsourcing relationships, empirical research was need. The
exploratory case studies, conducted in July–September 2004, had the following guiding
research question: “How do client and vendor organizations manage their IT outsourcing
relationships?”
The selection of cases was based on an instrumental approach, which means that the case
study was carried out to provide insight into issue or refinement of theory. “The case
is of secondary interest; it plays a supportive role, facilitating our understanding of
something else. The choice of case is made because it is expected to advance our
understanding of that other interest” (Stake, 1994, p. 237). All three cases were selected
for their paradigmatic characteristics in terms of their outsourcing undertaking. In other
words, the cases were selected because the ABB–IBM is a global one, the SAS–CSC
contract belong to the largest buy-outs in Europe, and the Rolls-Royce–EDS contract
is mature one. All cases are unique with global client companies from different industries,
and all vendor companies are global service providers. In all three international-based
cases more than a thousand employees were transferred from client to vendor organiza-
tions. They provide a broad base of relationship practice, suggesting that a case in each
company would be of interest and value to this research study. Figure 1.2 shows some
characteristics of the IT outsourcing relationships studied.
Figure 1.2. Three international-based case studies (source: press releases)
Client
company and
interviewee

Industry Origin Outsourced Start o
f
dea
l
Length o
f
dea
l
Size o
f
dea
l
Number o
f
peopl
e
transferre
d
Customer o
f
vendo
r
compan
y
Rolls-Royce Power for civil
aerospace, defense

aerospace, marine
,
and energy

markets
UK Infrastructure
,
application
support, and
development
200
0
(1996
)
144 month
s
$2.1
b
1,22
0
ED
S
ABB Power and
automation
technologies
Switzerland

Data center,
infrastructure
,
desktop
July 28
,
200

3
120 month
s
$1.1
b
1,20
0
IBM

Scandinavian
Airlines
(SAS)
Air travel and
airline-related
businesses
Nordic Infrastructure

management,
application
development,

and support
Decembe
r
18, 200
3
60 month
s
$1.47
b

1,15
0
CSC


Introduction 5
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permission of Idea Group Inc. is prohibited.
Data collection was conducted through a total of 16 interviews, with questions address-
ing enter and exit strategies, phases and activities, contract development, personnel
issues, governance structures and relationship management, and knowledge manage-
ment, with a strong emphasis on what characteristics influenced successful IT outsourcing
relationship. For each client–vendor outsourcing relationship, two to three interviewees
were selected from each organization. Interviews were either personal meetings or by
phone.
The individual cases serve only as the evidentiary base for the study and are used solely
in a cross-case analysis. The book’s purpose is not to portray any single one of the
relationships. Rather, the book synthesizes the lessons from all of them and is organized
around the topics of Chapters V to XII. In addition, a brief context and overview about
the individual cases is presented as abbreviated vignettes at the end of Chapters II to
IV .
6 Gottschalk & Solli-Sæther
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permission of Idea Group Inc. is prohibited.
Chapter II
IT Outsourcing
Given the potential headaches of managing IT, it is tempting to hand the job over to
someone else. Indeed, outsourcing once appeared to be a simple solution to management
frustrations, and senior management teams at many companies negotiated contracts with
large service providers to run their entire IT functions. At a minimum, these providers

were often able to provide IT capabilities for a lower cost and with fewer hassles than
the companies had been able to themselves. But many of these outsourcing arrangements
resulted in dissatisfaction, particularly as a company’s business needs changed. Service
providers, with their standard offerings and detailed contracts, provided IT capabilities
that were not flexible enough to meet changing requirements, and they often seemed slow
to respond to problems. Furthermore, a relationship with a supplier often required
substantial investments of money and time, which entrenched that supplier in the
company’s strategic planning and business processes. The company then became
particularly vulnerable if the supplier failed to meet its contractual obligations (Ross &
Weill, 2002).
Problems arose because senior managers, in choosing to outsource the IT function, were
also outsourcing responsibility for one or more of the crucial decisions they should have
been making themselves. Companies often hired outside providers because they were
dissatisfied with the performance of their own IT departments—but that dissatisfaction
was primarily the result of their own lack of involvement. In light of this track record, most
larger companies, at least, are deciding to keep their main IT capabilities in-house. But
many engage in selective outsourcing. Good candidates for this are commodity services,
such as telecommunications, in which there are several competing suppliers and
specifications are easy to set, and services involving technologies with which the
company lacks expertise. Unlike decisions to outsource the entire IT function, selective
outsourcing decisions are usually best left to the IT unit, assuming that senior manage-
ment has taken responsibility for overall strategy.
IT Outsourcing 7
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permission of Idea Group Inc. is prohibited.
Beaumont and Costa (2002) studied IT outsourcing in Australia. They found that almost
40% of Australian organizations outsource one or more IT applications. Large organi-
zations tended to outsource more than small ones. The three most important reasons for
outsourcing were access to skills, improved quality and focus on core business. Four
factors contributed to successful outsourcing: a tight contract, a partnership, a change

process, and the IT manager’s role changing from managing projects and operations to
acquiring and managing the internal and external resources required to do the organization’s
IT work.
Successful IT outsourcing relationships enable participants to achieve organizational
objectives and to build a competitive advantage that each organization could not easily
attain by itself. Outsourcing success can be viewed as the level of fitness between the
customer’s requirements and the outsourcing outcomes. Outsourcing success can be
measured in terms of both business and user perspectives. From a business perspective,
outsourcing is motivated by the promise of strategic, economic, and technological
benefits. The success of outsourcing, then, should be assessed in terms of attainment
of these benefits. From a user perspective, outsourcing success is the quality level of
services offered. A decision to outsource on the basis of saving costs without analysis
of the quality of services frequently leads to higher costs and lower user satisfaction.
Therefore, it is imperative to conduct a proper analysis of the service quality before
building a relationship with a service provider for a successful outsourcing arrangement
(Lee & Kim, 1999).
Transformational Outsourcing
The traditional way of thinking in IT outsourcing is to move the current IT function out
of the organization and let another organization handle it. There is no strategic thinking
behind it, except the idea of solving a problem, saving some money or improving a
function by means of some undefined solutions. The new way of thinking is to make IT
outsourcing part of a strategic transformation of the IT function, where new tasks and
roles are implemented to replace old tasks and roles. A classic example of this new way
of thinking is the transformation of the IT function at British Petroleum (BP) in the 1990s.
The IT function went through a fundamental transformation consisting of the following
changes (Cross, Earl, & Sampler, 1997):
• From systems provider to infrastructure planner. The mission of the IT function
shifted from developing systems to overseeing technical integrity and pursuing
value creation and cost-reduction opportunities through information sharing.
• From monopoly supplier to mixed sourcing. In 1991, outsourcing of operations,

telecommunications, systems development, and IT maintenance began, as BP
recognized that it was not essential that these were carried out in-house. Some local
sites already had experience in facilities management, and as contracts came up for
renewal, lessons were recorded and a worldwide outsourcing program was imple-
mented.
8 Gottschalk & Solli-Sæther
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• From business standards to industry standards. IT managers have long been
concerned about coordinating various types of computing and communication
equipment. However, throughout most of the research on IT infrastructure, the
focus has been directed at creating and managing the internal infrastructure.
Therefore, BP spearheaded a unique initiative to help create an external software
market by being one of the early advocates and founding members of the
Petrotechnical Open Software Corporation, which was joined by a number of oil
companies such as Elf, Mobil, Statoil, and Texaco.
• From decentralized bias to centralized top sight. The senior management team
realized that the major benefit of centralized management of IT is not budget
authority, but is in setting standards for infrastructure. While some IT resources
still remain in the local businesses, it is the job of the top IT management team to
provide the global perspective for infrastructure planning and cost control, which
is here called top sight.
• From systems analysts to business consultants. A new skill set was defined for IT
personnel. The new skill set has an equal balance between business, technical, and
people skills. Such a radical change in the skill set of IT staff has been supported
by a number of human resource initiatives such as skills testing, self-assessment,
and personal development planning.
• From craftsmen to project managers. IT personnel no longer approach their job as
craftsmen, viewing each job as a unique, customized process. Their task has
switched to that of project managers, integrating and coordinating stakeholders

involved in providing IT applications and operations.
• From large function to lean teams. Team orientation was stimulated in different
ways. For example, staff was moved around the world to create global not local
loyalties. A team-building and team-working program was introduced stressing the
use of multifunctional teams and diluting the functional focus.
The IT budget was reduced from $360 million in 1989 to $132 million in 1995 after this
transformation. IT personnel were reduced from 1,400 persons to 150 persons in these
six years. Hence, a large portion of the reduced IT budget went to external outsourcing
vendors. As this pioneering case of IT outsourcing illustrates, outsourcing can be more
than a tool for cutting costs and improving organizational focus. Increasingly, it is a
means of acquiring new capabilities and bringing about fundamental strategic and
structural change.
According to Linder (2004), the concept of transformational outsourcing is an emerging
practice, where companies are looking outside for help for more fundamental reasons—
to facilitate rapid organizational change, to launch new strategies, and to reshape
company boundaries. In doing so, they are engaging in transformational outsourcing:
partnering with another company to achieve a rapid, substantial, and sustainable
improvement in enterprise-level performance.
Transformational outsourcing places the power to bring new capabilities to the organi-
zation squarely in the hands of executives who have and value those capabilities. In other
words, the outsourcing partner provides a management team that is experienced in the
IT Outsourcing 9
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permission of Idea Group Inc. is prohibited.
capability that the organization seeking change needs. And those executives are
empowered by the outsourcing process to implement the practices they bring with them.
Not all transformational outsourcing initiatives are alike. Linder (2004) identified four
broad categories from her research on 20 companies that have attempted the practice. The
four categories are start-ups (outsource to rapidly scale up a new business), pathway to
growth (outsource to fix a key process that stands in the way of growth), change catalyst

(outsource to signal broad change and focus on adding value), and radical renewal
(outsource to improve core operating capabilities radically).
As executives obtain more experience with outsourcing, they are learning the tool’s
potential and beginning to wield it for more strategic purposes. Some will use it to shape
and reshape their business models. Instead of massive, sweeping changes, many
organizations will master the ability to use outsourcing to make continuous incremental
improvements. But while the potential benefits are incontrovertible, the art of joining
organizations with unique capabilities is extremely challenging and requires visionary
leaders with strong hearts and a large capacity for hard work. By combining the tool’s
execution effectiveness with their own growing skills in partnering, leaders who display
those characteristics will have a practical and realistic road map at their disposal for
building strategic flexibility.
Transformational outsourcing is an emerging practice, but the track record of companies
that have engaged in it is impressive. In a study of 20 companies, 17 of them have been
in place long enough to show results. Of that group, 13 have achieved dramatic,
organization-level impact. To the extent that other companies can replicate such success,
transformational outsourcing may become a more effective way of improving perfor-
mance than major internal change initiatives, mergers and acquisitions, or joint ventures
(Linder, 2004).
The key issue is new capabilities. In undertaking an internal initiative, a company has
concluded that it lacks an important set of skills, otherwise it would not be seeking
transformation. But it often proves too time consuming to develop the skills internally.
In a mergers-and-acquisition scenario, the company acquires the capabilities it lacks, but
cultural clashes often interfere with its ability to use them effectively. An acquiring
company seldom, for example, puts executives from the acquired company in charge of
its own organization in order to learn from them. Similar cultural impediments make it
unlikely that a company will transform itself with the expertise it gains in a joint venture.
But transformational outsourcing places the power to bring new capabilities to the
organization squarely in the hands of executives who have and value those capabilities.
The outsourcing partner provides a management team that is experienced in the

capability that the organization seeking change needs. And those executives are
empowered by the outsourcing process to implement the practices they bring with them.
Transformational outsourcing is concerned with bringing new capabilities to the orga-
nization through important sets of skills. These skills can be found in knowledge work,
and knowledge management emerges as an important discipline in transformational
outsourcing. Executives have to lead a transformational outsourcing initiative much
differently from the way they would manage conventional outsourcing.
10 Gottschalk & Solli-Sæther
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permission of Idea Group Inc. is prohibited.
Outsourcing Decisions
The decision to outsource or insource enterprise-wide activities related to the acquisi-
tion, deployment, and management of IT represents one of the more complex choices
facing a firm’s managers. On the one hand, insourcing requires management to commit
significant resources to a course of action, the effects of which may be costly to reverse,
while forgoing numerous advantages associated with the marketplace. On the other
hand, insourcing may be required for a firm to accumulate resources necessary to
generate or maintain a competitive advantage.
The complexity of this decision is demonstrated in research conducted by Leiblein,
Reuer, and Dalsace (2002). They examined the relationship between governance choice
and technological performance. In contrast to popular arguments suggesting that
insourcing or outsourcing will lead to superior technological performance, they found
that governance decisions per se do not significantly influence technological perfor-
mance directly. Rather, observed differences in the performance of transactions gov-
erned by different organizational forms are driven by factors underlying governance
choice. While the increasing rapidity of technological change and the increasing
dispersion of knowledge suggest an increased role for outsourcing in the economy, the
relationship between governance choice and performance is dependent on the distribu-
tion of relevant capabilities and the degree to which performance is driven by autono-
mous or systemic innovation.

Empirical evidence suggests that carefully crafted outsourcing strategies increase the
overall performance of the firm. Outsourcing is generally considered as a very powerful
tool to cut costs and improve performance. Through outsourcing, firms can take
advantage of the best outside vendors and restructure entrenched departments that are
reluctant to change. Outsourcing can also help focus on the core business. Since
building core competencies and serving customer needs are critical to a firm’s success,
anything that detracts from this focus may be considered for outsourcing (Barthélemy,
2003b).
The decision to outsource is influenced by a number of factors. In this book, we will
discuss factors such as production economies, transaction economies, technological
uncertainty, functional complexity, transaction-specific investments, supplier presence,
slack resources, and criticality of IT. Many more factors will be presented.
IT Outsourcing Markets
Research on global computing services shows that there has been a massive growth in
the number of large outsourcing deals signed in continental Europe. The Global
Computing Services’ contracts database tracks all outsourcing, integration, and consult-
ing deals with a value greater than $1 million, and in the major part of 2003, it tracked $21.32
billion of deals in the region —a huge 173% increase on the $7.81 billion deals tracked
in 2002. This made continental Europe the fastest growing territory for major IT services
IT Outsourcing 11
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permission of Idea Group Inc. is prohibited.
deals in 2002, ahead of the U.K., which showed a 110% increase. The value of the 10 largest
outsourcing deals in continental Europe is listed in Table 2.1 (as of December 11, 2003).
Another good indicator of the health of the outsourcing market across various geogra-
phies is to look at the number of IT services deals signed with a value greater than $100
m—almost all of which are long-term outsourcing deals. There has been a huge surge in
the number of these mega-deals in continental Europe during 2003. Global Computing
Services has tracked 46 contracts with a value of $100 million or more in 2003, compared
to just 13 in 2002. The number of mega-deals increased by 27% in the rest of the world,

by 14.5% in the United States, and by 6.4% in the U.K. The growth in the market for IT
service deals is shown in Table 2.2.
The outsourcing market can also be studied in terms of industries. For example, the
healthcare industry in the United States was studied by Lorence and Spink (2004). They
found that IT functions in healthcare organizations most likely to be outsourced to
external vendors or consultants were transcriptions (patient data) and microfilming.
Overall, nonmanagement IT functions were more likely to be outsourced, especially
where more use of computerized patient data results in increased demand for IT
outsourcing. The impact of organizational factors in outsourcing preferences also
suggested that outsourcing decisions, rather than being function specific, might be the
result of a more general level of comfort for outsourcing across the organization as a
whole.
There seems to be some key forces shaping the outsourcing market. According to
consulting organization Gartner (2004a), real-time delivery offerings require major shifts
Table 2.1. The 10 largest outsourcing deals in continental Europe in 2003
(ComputerWire, 2003)
Rank

Vendor Client Project Region Value Length Date
1 IBM Global Services Nordea Bank Infrastructure management,

Server management, Desk-
top management
Sweden $2.66
b
120 month
s
October 1
,
200

3
2 T-Systems Daimler-Chrysler Network management,
Infrastructure management,

Desktop management
Germany $1.40
b
36 month
s
August 11
,
200
3
3 IBM Global Services ABB Data center outsourcing,
Infrastructure management,

Desktop management
Switzerland

$1.10
b
120 month
s
July 28
,
200
3
4 IBM Global Services AXA Sun Life Infrastructure management,

maintenance/support, serve

r
management
France $1.00
b
72 month
s
February 27
,
200
3
5 IBM Global Services M-Real Application development
and support, Infrastructure
management
Finland $645.8 m

120 month
s
June 11
,
200
3
6 Hewlett-Packard Bank of Ireland Desktop management,
Server management, Infra-
structure management
Ireland $600 m

84 month
s
Novembe
r

28, 200
3
7 EDS Corp. Ministry of Flemish

Community
Network management,
application development
and support
Belgium $513 m

60 month
s
June 27
,
200
3
8 Computer Sciences Co
.
ISS AS Infrastructure management,

Network management,
Desktop management
Denmark $450 m

120 month
s
May 27
,
200
3

9 IBM Global Services Lego Company Infrastructure management,

Computer engineering,
Maintenance/support
Denmark $400 m

60 month
s
August 11
,
200
3
10 IBM Global Services Banco Comercial
Portugues
Infrastructure management,

Business continuity/disaste
r
recovery
Portugal $391 m

120 month
s
July 4, 200
3

12 Gottschalk & Solli-Sæther
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permission of Idea Group Inc. is prohibited.
in outsourcing contracting models, including financing, pricing, service levels, asset

management, risk management, and standards. A long-term development road map for
real-time infrastructure and real-time delivery can be essential for competitive differen-
tiation in outsourcing. For example, outsourcing vendors must optimize the management
and financing of IT assets to deliver the on-demand, pay-per-use promises of real-time
delivery. IT infrastructure consolidation and standardization characterized the largest
multibillion dollar IT outsourcing contracts during 2003 and are expected to continue for
several years. These outsourcing contracts are not just exercises in cost reduction
necessitated by economic problems, but they are also intended to advance the clients
toward becoming real-time enterprises through the benefits of emerging real-time
infrastructure and real-time delivery services. Gartner defines a real-time enterprise as an
enterprise that competes by using up-to-date information to progressively remove
delays to the management and execution of its critical business processes.
Business Application Outsourcing
Dramatically reduced network cost due to the Internet and virtual private networks, the
ever-increasing supply of bandwidth, and advances in the security of Internet-based
transactions have led to the emergence of application service providers (ASPs), a new
category of IT service firms. An ASP can be defined as an organization that manages and
delivers application capabilities to multiple entities from a data center across a wide area
network. User organizations can access software applications from one or more ASPs
over the Internet for a subscription fee (Susarla, Barua, & Whinston, 2003).
In a typical business, we find several IS applications. For example, Weill and Vitale (1999)
identified an applications portfolio of 18 systems in a manufacturing business: budget-
ing, capital projects, customer complaints, debtors, general ledger, freight cost manage-
ment, fixed assets, human resource management, inventory, market data, multiplant
accounting, office support, payroll management, pricing and sales, purchasing, sales
forecasting, product safety system, and trading accounts management. These systems
Table 2.2. Growth in IT service deals by region between 2002 and 2003 (ComputerWire,
2003)
Continental
Europe

United
Kingdom
United
States
Rest of the
World
Value of contracts in 2003 (t
o
December 11)
$21.32
b
$23.65
b
$44.74
b
$10.53
b
Value of contracts in 2002 (fu
ll
year)
$7.81
b
$11.27
b
$42.05
b
$14.32
b
% Change +173%

+110%

+ 6.4%

?26.5%

Number of $100 m+ contracts i
n
2003
4
6
3
3
9
5
2
8
Number of $100 m+ contracts i
n
2002
1
3
3
1
8
3
2
2
% Change +254%

+6.4%

+14.5%

+27%


IT Outsourcing 13
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permission of Idea Group Inc. is prohibited.
support tasks in peoples’ jobs. For example, all systems help planning, investigating,
coordinating, evaluating, supervising, staffing, negotiating, and representing to a
varying extent.
User organizations can access software applications from one or more ASPs over the
Internet for a subscription fee. A key selling point for ASP services involves a shorter
time period required to implement new software applications. For businesses plagued by
high turnover of IT staff, inadequate organizational resources to maintain and upgrade
existing IT applications, and large capital requirements for major IT implementation
projects, the ASP business model could be an attractive alternative with its off-the-shelf
IT applications subscription approach. Sophisticated ASPs have gone as far as offering
enterprise resource planning, e-commerce, and supply-chain applications, which may
involve integration with existing IS in a user organization (Susarla et al., 2003).
While the ASP model has the potential to fundamentally change the manner in which IT
services are provided to user firms, to date ASPs have had a limited success in signing
up customers. Moreover, several customers of ASPs are unsatisfied with their service,
which questions the viability of the ASP business model and selection of ASP as an enter
strategy for IT outsourcing. Evidence also points to the fact that ASPs themselves have
to rework their service strategies in response to market demand. It has long been
recognized that market success depends on designing services to match customer needs
and that customer satisfaction has a positive impact on market share and profitability.

Satisfied customers are more likely to engage in positive word of mouth, thus lowering
the cost of attracting new customers. Satisfaction based on successful exploration and
exploitation of the vendor value proposition plays an important role in building other
important assets for the firm. A focus on satisfaction is important for ASPs if they have
to retain existing customers as well as attract new customers (Susarla et al., 2003).
This calls for an assessment of the determinants of client satisfaction with ASPs and
evaluation of the effectiveness of the ASP mode of service delivery over the Internet.
Susarla et al. (2003) analyzed the determinants of satisfaction in ASP service provision.
Their analysis shows that the satisfaction with an ASP is negatively affected by the
disconfirmation effect, but positively influenced by the perceived provider performance
and prior systems integration, which is a measure of integration of organizational
systems prior to using ASP services. Disconfirmation is the negative discrepancy
between expectation and performance.
Further, perceived provider performance is positively influenced by the functional
capability of the ASP and the quality assurance by the ASP, but negatively influenced
by the prior systems integration. These findings suggest that, to be successful, ASPs
must strive to reduce the disconfirmation effect faced by adopting organizations and to
enhance the perceived quality of their solution, possibly through partnerships with
leading IT vendors. Further, ASPs must improve the integration of their offerings with
existing applications in user organizations, which may require alliances with IT firms that
specialize in integration services. From a client perspective, an enter strategy of ASP
selection may thus focus on integration with existing IT, performance delivery, and
standards of software capability. From a vendor perspective, the findings of Susarla et
al. (2003) indicate a need for ASPs to facilitate integration with existing IT in client
organizations, ensure superior performance delivery, emphasize rigorous enforcement
14 Gottschalk & Solli-Sæther
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of service agreements, and ensure that their application meets standards of software
capability. Their finding that ASPs are not evaluated on some of the prior experiences

of the organizations is favorable to vendors, since it suggests that firms that are Internet
savvy or that have a strong IT department are not going to have unreasonably high
expectations from the ASPs.
A related area of exploration is an analysis of how organizational users form expectations
about an ASP’s services. The literature on outsourcing posits that the trade press,
discussion with peers, consultants’ forecasts, and the business strategy pursued by the
company can contribute to the formation of expectations in the outsourcing context. As
the IT outsourcing literature has documented, management defines the scope of the
outsourcing and the sourcing criteria, while the IT department can provide insights into
the technological reasons for outsourcing and judge the success of the outsourcing
project in terms of performance outcomes that are met. Expectations that need to be
realized in the outsourcing context may reflect the consensus among the different
stakeholders in the organization (Susarla et al., 2003).
Business Process Outsourcing
Enterprise restructuring is expected to provide fertile ground for outsourcing in the
business process outsourcing market segment. Some companies turn to outsourcing to
foster change management during consolidation and integration. Consolidation, merg-
ers and acquisitions result in integration needs for back-office processes, which are often
met by outsourcing. Divested companies need to grow entire back-office functions from
scratch and look to external services providers to provide this process-management
capability. Business process outsourcing includes enterprise services (human re-
sources, finance and accounting, payment services, and administration), supply man-
agement (buying processes, storing processes, and moving processes), demand man-
agement processes (customer selection, customer acquisition, customer retention, and
customer extension), and operations. A typical business process outsourcing contract
includes discrete project-based IT services, ongoing IT management services, and
general process management (Gartner, 2004b).
Business process outsourcing often fills human resources (HR) practitioners with fear,
but handled properly, it can help the HR function become more efficient and strategic.
Of all the business-related acronyms that are filtering through to the corporate con-

sciousness, BPO (business process outsourcing) is certainly one that appears to be
raising interest. BPO, although often seen as the next evolutionary step in IT outsourcing,
is also very different from it. BPO is about delegating the ownership, administration, and
operation of a process to a specialist third party in order to solve a business problem.
And because BPO is about delivering outcomes—higher-performing business pro-
cesses—it aims to raise a client company’s shareholder value (Strategic HR Review,
2004).
Business processes within a company can be broken down into three categories: core;
business critical noncore; and finally noncore, noncritical. Core processes are seldom