Information Systems Outsourcing: Linking Transaction Cost and Institutional Theories

Abstract

In this article, we apply transaction cost theory (TCT) and institutional theory to the realm of IS outsourcing. TCT posits that firm's outsourcing governance is influenced by transaction cost factors, namely, bounded rationality, opportunism, and risk. Institutional theory, on the other hand, has been advocated to explain non-choice behavior of organizations in the context of competitors, norms, and professional associations. Although TCT has been used extensively in the extant literature to study outsourcing arrangements, we argue that as IS outsourcing practices propagate in organizational fields, TCT explanations will take a back seat to institutional explanations. We appropriate the transaction cost framework to the IS outsourcing setting and consider when and how firm's decision to adopt outsourcing and corresponding ex-ante screening and ex-post monitoring of the vendor will be influenced by mimetic, normative, and coercive institutional pressures. More specifically, we argue that greater the density and rate of adoption in outsourcing during innovation diffusion and stability stages, the greater the possibility that transaction cost factors will be replaced by institutional factors in explaining firms' governance structures (decision to adopt outsourcing, and corresponding screening and monitoring). Conversely, we posit that when the institutional pressures are relatively weak, TCT better explains the intricacies of IS outsourcing arrangements. In conclusion, future research directions and managerial implications of the institutional environment on IS outsourcing governance are discussed.

Escaping ‘localisms’ in IT sourcing: tracing changes in institutional logics in an Italian firm

“…The first finding is that, while organizations in times of change may want to minimize transaction costs (Ang & Cummings, 1997), the institutional environment shapes IS sourcing decisions more than cost considerations. This is in line with Vitharana & Dharwadkar (2007). However when companies begin to engage into activities that influence their appreciation of institutional logics (Currie & Guah, 2007), they can also become selective in how the institutional environment influences them (Chen & O'Mahony, 2009).…”

“…They can guide actions in certain directions independently and/or in contrast with transaction costs (Vitharana & Dharwadkar, 2007). As Vitharana & Dharwadkar (2007) note, even a traditionally cost-conscious industry such as banking can be the victim of institutional logics: The American Banking Association (ABA) endorses specific IT service providers and provides vendors' listings to member banks (www.aba.com), which allows members to skip the step of structuring optimal contracts and instead adopt standard practices and ABA-endorsed service providers.…”

“…Over time, normative pressures permeate organizations and dictate what should be done and how to approach problems. For example, when a firm realizes that most of its competitors outsource, it may tend to adopt similar outsourcing practices to achieve legitimacy among its customers and business partners (Vitharana & Dharwadkar, 2007).…”

“…European Journal of Information Systems (2012) 21, 388-403 More recent literature acknowledges that sourcing decisions also depend on less tangible nonchoice behaviors, including the cultural and institutional issues that determine the norms by which companies operate (Leidner & Kayworth, 2006;Martinsons, 2008). The institutional environment, as well as the nature of the institutional pressures -normative or mimeticand the impact of 'human frailty' affect sourcing decisions (Ang & Cummings, 1997;Miranda & Kim, 2006;Vitharana & Dharwadkar, 2007). History plays a role in the otherwise simple linear continuum between two extremes (Boisot & Child, 1996;Makadok & Coff, 2009).…”

My choice, your problem? Mandating IT use in large organisational networks

“…Smith et al, 2010;Berger, 2014), large corporations (e.g. Stalk et al, 1992;Klein & Krcmar, 2006), industry associations (Vitharana & Dharwadkar, 2007) (e.g. Vitharana & Dharwadkar, 2007), and professional associations (e.g.…”