Lecture 4 - ITO Theories Flashcards
1
Q
Why is ITO important?
A
- The cost, and the hidden costs (of IT): Productivity drain, IT risk (data security, business continuity), misalignment of technology with business goals
- Technology uncertainty
- ITO remains controversial due to the unforeseeable success or failure
2
Q
What are the areas/things in IT you can outsource?
A
- Programming, software testing and software maintenance
- IT research and development
- High-end jobs such as software architecture, product design, project management, IT consulting and business strategy
- Physical products manufacturing-semiconductors, computer components, computers
- Business process outsourcing/IT Enabled Services
- Insurance claim processing, medical billing, accounting, bookkeeping, medical transcription, digitization of engineering drawings, desktop publishing, and high-end IT enabled services such as financial analysis and reading of X-rays
- Call centers and telemarketing
3
Q
Stages in outsourcing (decision-making)
A
Phase 1: Decision process
- Intelligence –> Why (determinants, (dis)advantages)
- Design –> What (alternatives, degree of ownership/outsourcing)
- Choice –> which (guidelines, stakeholders, evaluation —> very costly for firms)
Phase 2: Implementation
Implementation –> how (vendor selection, relationship buildings/management
–> outcome (experiences/learning, types of success, determinants of success)
Assumptions:
- Decisions are not performed by agents with perfect rationality (they don’t know everything, they have biases, cognitive limitations etc.)
- The quality of decisions vary as a function of the expertise of the decision maker
- To understand decision making, it is paramount to investigate the cognitive processes involved; that is, an analysis based on performance only is not sufficient
4
Q
Transaction Cost Economics/Theory (TCE/TCT)
A
- Transaction costs, also known as coordination costs, are defined as the costs of all the information processing necessary to coordinate the work of people and machines that perform the primary processes.
o Finding suppliers, negotiating prices, drawing up contracts and enforcing contracts
o E.g. the issue of writing a contract. This is not part of the original cost of the products. Still it has to be borne by someone (buyer or seller or both). Also information is not free (contrary to neoclassical view) - Production costs include the costs incurred from the primary processes necessary to create and distribute the goods or services being produced.
- TCE/TCT states that the costs and difficulties associated with market transactions sometimes favor hierarchies (or in-house production) and sometimes markets (external supplier) as the preferred governance structure.
o You add up the costs for in-house vs markets and based on that you decide - If information were complete and economic actors were perfectly rational, competent, and trustworthy, transaction costs would theoretically not occur.
- However, bounded rationality, which stems from humans’ information processing limitations, restricts actors’ abilities to identify qualified exchange partners, establish prices, and write contracts that anticipate all contingencies and sources of potential future conflict.
o This human limitation opens the potential for two exchange hazards that create transaction costs: opportunism and maladaptation
5
Q
Asset specificy (TCT)
A
Degree to which the assets used to conduct an activity can be redeployed to alternative uses and by alternative users without sacrafice of productive value
(the level of unique investment supporting a transaction) (Site, physical asset, human asset - opportunism. The more unique the asset, the harder to acquire –> higher transaction costs). Unique = Made for one very tiny little thing that applies to only one of my products, if this goes out next year I can’t do anything else with it.
6
Q
Uncertainty (TCT)
A
- -> Volume uncertainty is created by unpredictability regarding future demand levels,
- -> technological uncertainty is created by the unknown future trajectory surrounding an emerging technology (demand, supply, inflation etc.), and
- -> behavioral uncertainty occurs when managers are unable to evaluate the quality of activities because they are either technologically complex or hidden from view -opportunism (what is the true value of a consultant?)
7
Q
Frequency (TCT)
A
The level of recurrence of the activities needed by the firm for the transaction
8
Q
Cost analysis for outsourcing decisions
A
ΔC is Production costs difference (internal cost -market cost)
ΔG is Transaction costs difference (internal cost -market cost)
(ΔC + ΔG) > 0 use market activities
(ΔC + ΔG) < 0 use internal organization
(ΔC + ΔG) = 0 indifferent
But, you need to take the asset specificity, uncertainty and frequency into account
If uncertainty goes up –> The more likely to do it in-house. The A point is shifted, so that it is clear to do it in house
If uncertainty goes down –> The more likely to outsource. The A point is shifted, so that it is clear to outsource it
9
Q
Governance choice
A
- Asset specificity is the most important dimension of a transaction, but only in conjunction with bounded rationality/opportunism and in the presence of uncertainty.
- Non-specific assets call for the same governance mode –market, irrespective of the level of frequency and uncertainty.
o Without asset specificity, the rationale for vertical integration does not exist; there are no assets at risk and therefore no need of protection by means of vertical integration from possible opportunism.
o Standard contracts can be used (i.e. purchasing from the market) - The more idiosyncratic assets are, the more levels of uncertainty and frequency matter.
o When uncertainty is high, the appropriate governance is “internal organization,” irrespective of the frequency level. - The same is true for mixed assets.
- Due to the opportunism, for mixed and idiosyncratic assets both the costs and the possibilities of hold-up from opportunistic behavior are higher.
o Opportunism in conjunction with asset specificity is a leading factor in explaining decisions to vertically integrate (protect against risk) - Bounded rationality of decision makers requires provider flexibility
o Bounded rationality makes it hard to predict all the demand or technological changes of an uncertain environment in advance.
o Therefore, for highly specific assets and an uncertain environment, internal organization would be the appropriate governance mode.
o Detailed, elaborate and customized contracts can be used in situations of low uncertainty to mitigate opportunism of providers and the bounded rationality of decision makers. - When uncertainty is low to medium, assets are idiosyncratic, and the transaction is conducted only occasionally, customized contracting is the appropriate mode of governance.
- For a recurrent transaction with high level of specificity, internal organization is the appropriate governance choice.
- Customized contracting and internal organization are both mechanisms that serve to protect specific assets from
o potential opportunistic behavior by providers, and
o the inability of decision makers to predict all the contingencies and changes of the environment ex ante.
See the table on page 48 for an overview of the choice, while taking into account asset specificity, uncertainty and frequency
10
Q
Outsourcing risks
A
- Bounded rationality/opportunism (supplier lock-in)
- A shift in power is expected to take place overtime, where one player dominates the other (Power-Dependence theory)
o Firms can become locked-in as a result of their dependence on another party and thereby shift into a power disadvantage position (e.g. exclusive supply agreements together with high product demand)
o Suppliers may provide firms with attractive prices in the pre-contractual phase, and then afterward renegotiate in light of their latest dominance of the relationship
o The trap is caused by exit barriers that are derived from relationship specific investments and resource dependence including transaction costs, learning costs, technological costs, legal costs and cultural, time and geographical constraints
11
Q
Lessons from Dutch IT outsourcing
A
Controllable success factors
- Three controllable factors significant
(the quality of) Communication inside vendor’s organization, demand management, and strictly working according to the transition plan.
- Six controllable factors not significant
The other six controllable success factors did neither show discriminative nor predictive power. From this it does not follow, however, that these success determinants do not matter. It certainly makes sense to keep track on them for other reasons. - Predictive model
Next to discriminating between failure and success we were also interested in the odds for such outcomes. It turned out that improving demand management and internal communication within the supplier organization increased the odds of success the most. Although sticking to the transition plan also turned out to increase the odds in our study, it did not have that much of an effect. - Retention of expertise
One would have expected that retention of expertise within the client organization would have been key in increasing the odds (internal experts who know the drill of the IT-systems). However, the impact on the chance of success could not be estimated. In spite of that, we do think that having in-house expertise is crucial for the user organization (to manage the service provider, better perception of success or failure and factual reality) - Business case
Although a solid business case that is properly managed throughout the project is a useful addition, the impact on the chance of success could not be estimated. - Transfer of staff/assets
Can be part of a deal. The local IT-personnel will benefit from the new environment of the IT-service provider whose core business is obviously IT. Remarkably, transfer of staff appeared to be a risky endeavor. - Client communication
It makes sense that effective internal communication would make organizations more successful. So maybe that is true in general, but the impact on increasing the odds for a favorable sourcing deal could not be estimated.
Rigid success factors
Rigid, in the sense that they cannot be altered anymore, once the deal has been closed.
- Type of work
No correlation with success or failure between outsourcing either high-routine work in contrast with work that demands intimate business knowledge. - Organization culture
The (mis)match between the organization cultures of the service provider and his client was no signification factor in decreasing or increasing the change of success of a deal. - Client motive to outsource
Did not show up as a significant factor that made the difference between failure and success. Think about short-term cost reduction, guaranteeing operational continuity, access to knowledge and experience of the IT-service provider, focus on core activities. - Three rigid factors significant
Motivation for insourcing of the service provider, the service provider’s empathy, and hiring consultancy support. - Supplier motive to insource
The motive of the service provider to obtain the outsourcing deal turned out to be a discriminating factor. There were motives that lowered chance of success and vice versa. For instance, short-term motivations like increasing profit margins or business volume decreased the chance of success, while long-term (strategic) motivations like increasing market share or becoming a player increased the success rate. - Supplier empathy
There were clear indications that the capability of the service provider to imagine himself in the position of his client increases the chance of success of the deal. - Hiring consultancy support
Hiring sourcing consultants is contro-productive, it lowered the chance of success. It turned out that the degree of experience in outsourcing (either at the outsource, from external expertise or perceived outcome of the deal) was no convincing factor of success. External consultancy support makes the company not learning and taking responsibility, which can easily lead to failure.
12
Q
COBIT
A
To research, develop, publish, and promote an authorative, up-to-date, international set of generally accepted IT control objectives for day-to-day use of business managers, IT professionals, and assurance professionals
- In light of digital transformation, IT has become crucial in the support, sustainability, and growth of enterprises
o Previously, governing boards and senior management could delegate, ignore, or avoid IT related decisions
o In most industries, such attitudes are now ill advised
o Stakeholder value creation is often driven by a high degree of digitization in new business models, efficient processes, successful innovation etc. - Differences with COBIT5 include, for instance, new management objectives focused on data
- Strengthens the understanding, design, implementation, exercise, and evaluation of internal control through improved focus on information criteria and IT-related control objectives
- Strengthens management’s efforts to “ensure” and audit’s efforts to provide “assurance”
- Helps organizations in demonstrating their compliance with regulations such as SOX
13
Q
RACI chart
A
o Responsible (or recommender) o Accountable (or approver or final approving authority) o Consulted (or consultant or counsel) o Informed (or informee)
There is always only one person/role/group Accountable, multiple can be Responsible
14
Q
APO10: Manage Suppliers
A
o Key processes (identify relationships and contracts, select suppliers, manage relationships and contracts, manage supplier risk, monitor supplier performance and compliance)
o Management objectives for each key process (objectives on the categories mentioned above)
o Key activities for each key process (specific activities to manage the categories mentioned above)
15
Q
Neoclassical vs TCE
A
Behavioral assumptions:
- N: Assumes hyperrationality and ignores mores of the hazards related to opportunism
- TCE: Assumes bounded rationality
Unit of analysis:
- N: Concerned with composite goods and services
- TCE: Analyzes the transaction itself
Firm view:
- N: Describes the firm as a production function (technological construction)
- TCE: Describes the firm as a governance structure (organizational construction)
Property rights and contracts:
- N: Often assumes that property rights are clearly defined and that the cost of enforcing those rights by the means of courts is negligible
- TCE: Treats property rights and contracts as problematic
Efficiency:
- N: Recognizes profit maximization or cost minimization as criteria of efficiency
- TCE: Argues that there is no optimal solution and that all alternatives are flawed, thus bounding “optimal” efficiency to the solution with no superior alternative and whose implementation produces net gains
