A Comparison of Transaction Cost, Agency, and Knowledge-Based Predictors of IT Outsourcing Decisions: A U.S.-Japan Cross-Cultural Field Study

Abstract

As outsourcing evolves into a competitive necessity, managers must increasingly contend with the decision about which software development projects to outsource. Although a variety of theories have been invoked to study the initial outsourcing decision, much of this work has relied in isolation on one theoretical perspective. Therefore, the relative importance ascribed by managers to the factors from these theories is poorly understood. The majority of this work also masks interesting insights into outsourcing decisions by focusing on the information technology (IT) function rather than individual projects as the unit of analysis, where many of these decisions occur. In contrast, prior research at the project level has focused on predicting development performance in the postoutsourcing-decision phases of projects.The objective of this study is to examine the relative importance that IT managers ascribe to various factors from three complementary theories-transaction cost economics, agency theory, and knowledge-based theory-as they simultaneously consider them in their project outsourcing decisions. A secondary objective is to assess the cross-cultural robustness (United States versus Japan in this study) of such models in predicting project-level IT outsourcing decisions. We develop and test a multitheoretic model using data on 1,008 project-level decisions collected from 33 Japanese and 53 U.S. managers. Overall, our results provide novel insights into the 260 TIWANA AND BUSH relative importance that managers ascribe to the factors from these three theories, their complementarities and occasional contradictions, and offer new insights into the differences among U.S. and Japanese IT managers. Implications for theory and practice are also discussed.KEY WORDS AND PHRASES: agency theory, conjoint study, IT sourcing, Japanese software, knowledge-based theory, knowledge management, outsourcing, subcontracting, transaction cost economics, vendor selection.A chal l enging but important decision that contemporary information technology (IT) managers face is the decision about whether to outsource or internalize applications development projects. IT project outsourcing is defi ned as an interfi rm contractual arrangement in which an external software development organization (hereinafter "vendor") custom develops a software application for a client fi rm [48]. Although outsourcing is increasingly viewed as a competitive necessity, it is nevertheless a risky-and often irreversible-decision [32,50]. The stakes in such decisions are high considering that only one in six internal IT projects is successful (i.e., on schedule, within budget, and fulfi lls its intended goals), yet the annual IT outsourcing spending in the United States alone is approaching $50 billion [32]. It is therefore vital to understand how managers charged with outsourcing decision making actually arrive at those decisions.A review of the past two decades of literature reveals two overarching themes in IT outsourcing studies: (1) studies that...

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