Innovation in IT outsourcing relationships: Where is the best practice of IT outsourcing in the public sector?

In recent years IT outsourcing has evolved from a formal contractual-based practice to a relationship-based practice. This new practice is viewed as an innovation in IT outsourcing in the public sector. The main goal of this study is to conduct an empirical investigation on IT outsourcing projects in the public sector to examine the best IT outsourcing practices from the relationship perspective. A four outsourcing relationship types (FORT) framework is applied to 178 IT outsourcing projects initiated by 56 different government organizations in Korea. Data shows that the best practice of IT outsourcing in the public sector can be achieved when strategic impact of the outsourced IT is highest and the extent of substitution by the vendor is large but not fully substituted. This finding can be explained in terms of government organization's fear of loss of control and conservative organizational culture. Keywords: IT outsourcing, relationship management, FORT model, best practice.






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Publication: Innovation : Management, Policy & Practice
Author: Moon, Junghoon
Date published: August 1, 2010

INTRODUCTION

In recent years IT outsourcing has become a world-wide occurrence in both the private and public sectors. Following the trends of the private sector, IT outsourcing in the public sector too has become an accepted management practice. A large percentage of IT projects for E-government are now outsourced. As a result, IT outsourcing in the public sector in a increasingly common practice at all levels of government (Chen and Perry 2003). However, many of the IT outsourcing projects in the public sector have faced tough challenges, resulting in the failure of the some, even though success factors for IT outsourcing have been rigorously considered based on frequently referred principles and findings from previous research (Heeks 1999, Khalfan 2004).

In this situation, the importance of relationship between the customers and vendors is argued to be a critical factor to overcome those challenges (Goles and Chin 2005). Chen and Perry (2003: 44) have argued that IT outsourcing in the public sector should be considered 'a managed relationship rather than a traditional procurement'. Using the data collected in Korea, Lee (2001) has emphasized the importance of relationship for successful IT outsourcing in the public sector. Due to the importance of relationship management in IT outsourcing success, the IT outsourcing paradigm has shifted to the relationship based practice from the traditional pure contractual based model. This study views relationship management as an innovation in IT outsourcing practice. Innovation is usually concerned with creation and development of new ideas and solutions (Papinniemi 1999). Under this definition, this study identifies relationship management as an innovative solution for the successful practice of IT outsourcing in the public sector.

Some researchers have examined IT outsourcing relationships but they are limited to private sector (e.g. Goles and Chin 2005; Grover, Cheon and Teng 1996; Han, Lee and Seo 2008; Kern and Willcocks 2000; Kim and Chung 2003; Kishore et al. 2003; Lee, Huynh and Hirschheim 2008; Lee and Kim 1999). However, public organizations differ from private organizations both ideologically and operationally, both having different goals reflected in their ethics and values (Vilvovsky 2008). Cats-Baril (1995) point out that blindly adopting the framework developed for private sector can be misleading for public sector. Failing to clearly address differences between the public and private sectors can be a mistake in undertaking public sector IT outsourcing projects (Khalfan 2004).

The main goal of this study is to analyze the best IT outsourcing practice in the public sector in terms of relationship innovation. This study applies FORT (four outsourcing relationship types) model proposed by Nam, Rajagopalan, Rao and Chaudhury (1996) to 178 IT outsourcing projects in the public sector of Korea. The study offers a useful guideline to practitioners in public sectors and also to private sector vendors in understanding how to develop successful IT outsourcing relationships. As IT outsourcing in the public sector is little studied (Lin, Pervan and McDermid 2007) and empirical studies and reference works are few (Moon et al. 2007), this study also contributes to academic analysis.

RELATIONSHIP MANAGEMENT IN IT OUTSOURCING

Relationships in outsourcing are defined as 'an ongoing linkage between an outsourcing vendor and customer that has a long-term orientation and a mutual recognition and understanding that the benefits attained by each firm are at least in part dependent on the other firm' (Goles and Chin 2005). Relationships in outsourcing consequently occur with some type of exchange between the parties.

Maintaining a positive client-supplier relationships is central to achieving benefits from IT outsourcing (Klepper and Jones 1998). The relationship between the vendor and the customer plays a critical role in the success or failure of the outsourcing arrangement (Goles and Chin 2005). One way to create value in IT outsourcing is by building and sustaining a flexible relationship between customers and providers of IT outsourcing (Lee, Huynh, and Hirschheim 2008). Successful management of an outsourcing relationship thus requires a highly interactive and flexible relationship between two organizations to be sustained over the strategic planning horizon (Goo, Kishore, and Rao 2009) in which the management of the relationship may require modifications and adjustments of both the formal and the psychological contracts (Dibbern et al. 2004). As in any relationship, the interaction between client and the service provider often goes beyond the rules, agreements, and exceptions specified in a legal contract (Lee and Kim 2005). Relationship management in outsourcing thus has to focus on achieving the clients' objectives and over time it can be expected that the relationship will evolve to a different status, as it becomes embedded in day-to-day routines and each party's operations (Kern and Willcocks 2000).

Literature analysis of the top Management Information Systems (MIS) discipline journals over 1999-2008 reveals that IT outsourcing relationships management have dealt with various context and theoretical bases, mostly focused on achieving successful IT outsourcing projects by understanding relationship between service providers and service receivers (e.g. Beulen and Ribbers 2003; Goo and Huang 2008; Goo et al. 2007; Han, Lee, and Seo 2008; Koh, Ang, and Straub 2004; Lee 2001; Lee, Huynh, and Hirschheim 2008; Lee and Kim 1999; Mao, Lee, and Deng 2008; Olsson et al. 2008; Rustagi, King, and Kirsch 2008; Winkler, Dibbern, and Heinzl 2008). However, a closer analysis shows that these studies are limited to private sectors' IT outsourcing relationships. Due to the limited IT outsourcing relationships studies in the public sector and the fact that IT outsourcing relationships result not only through the operation of the contract, but also as a natural consequence of the resulting issues of dependency (Kern and Willcocks 2000) IT outsourcing relationship in the public sector is considered very critical.

RELATIONSHIP MANAGEMENT IN PUBLIC SECTOR IT OUTSOURCING

The few studies conducted on IT outsourcing relationships in public sector are mostly focused in identifying the importance of relationship management in IT outsourcing practice. Lee (2001) examines the impact of knowledge sharing, partnership quality and organizational capability on IS outsourcing success in public sector organizations and finds that partnership quality is a significant intervening factor between knowledge sharing and outsourcing success. Partnership and relationship term has been used interchangeably in IT outsourcing literatures. Willcocks and Kern (1998) analyze the case of the UK Inland Revenue to investigate process and management issues related to the contract and relationship between an outsourcing vendor and its client. They find that a properly structured contract is necessary but not sufficient for outsourcing success. Further, they argue that effective interaction between the parties at the cooperative level is necessary for a 'strategic partnering' outsourcing arrangement to succeed. Hancox and Hackney (1999) assess IT outsourcing arrangements and find that public organizations are more skeptical about the concept of partnerships with the vendor than are the private sector organizations and the type of IS function being outsourced is also found to impact the perceptions of partnership. They also argue that partnerships mostly occur in the area of systems development than in operations and IT infrastructures, where vendors need greater understanding of the organization.

As above, the studies in public sector IT outsourcing relationships are mainly concentrated in identifying the importance of relationships, yet there are no proper guidelines for public sector relationship practice. Public sector practitioners cannot directly adopt the guidelines developed for private sector as there are crucial differences between the two sectors in IT outsourcing. Lin et al. (2007) identify several differences between private and public sectors, including the manner of decision-making process, accountability in purchasing decision, personnel management and recruitment, risk of failures, organizational cultures, and management of information systems. Another distinct characteristic of public sector is inflexibility of the bidding process (Moon et al. 2007). In the public sector, once a contract specification has been agreed, it is very difficult for either partner to change it. While in private sector even during the contract period, developments and changes will continue (Burnes and Anastasiadis 2003). Furthermore, Burnes & Anastasiadis point out that public sector is more obliged by legislation during the supplier selection process but private sector is free to choose its supplier. Due to these distinct characteristics of the public sector, a different relationship with the vendor is expected. This is why public sector IT outsourcing relationship must be viewed differently with a distinct approach in carrying out public sector IT outsourcing projects.

INNOVATION AND EVOLUTION OF THE IT OUTSOURCING RELATIONSHIP

Outsourcing practices have evolved in several ways over the last few decades (Saunders, Gebelt, and Hu 1997). Traditionally IT outsourcing is based on formal contracts where parties involve sit together and negotiate the contracts. The contract provides a legally bound, institutional framework in which each party's rights, duties, and responsibilities are codified and the goals, policies, and strategies underlying the arrangement are specified (Gottschalk and Solli-Saether 2005). The parties involve expect that during the life of the contract, some form of renegotiations will be likely (Dibbern et al. 2004). However, with the increasing practice of IT outsourcing, the nature of the outsourcing relationship is shifting from a contractual to the one based on partnership (Lee 2001). In the public sector, Dawes and Prefontaine (2003) have recognized the nature of evolving and dynamic collaborative relationships between clients and vendors.

The shift towards a relationship based IT outsourcing in the public sector is identified as an innovation in this study. Innovation has been defined in a multitude of ways from a variety of perspectives and disciplines. According to (Naranjo-Gil 2009) innovation is defined as any practice, process, product or service that is new to the environment of the organization. Further Naranjo-Gil (2009) explains that the practice should be different from the current or past practices of that organization and should not be widely used by other organizations in the environment. The relationship based IT outsourcing is a new practice in the public sector environment to improve outsourcing results. Innovation in IT outsourcing relationship can also be viewed as organizational innovation as it refers to 'the adoption of an idea or behavior that is new to the organization adopting it' (Draft 1978, p. 197).To obtain a better performance from the innovation of relationship in IT outsourcing it is important for the organizations to possess the best practice. In this regards, this study explores the best practices of IT outsourcing relationships in the public sectors.

THE FORT (FOUR OUTSOURCING RELATIONSHIP TYPES) MODEL

Best practice in IT outsourcing relationships can be examined using the FORT model proposed by Nam et al. (1996) to categorize the diverse patterns of outsourcing based on two dimensions, namely 'the extent-of-substitution dimension' and 'the strategic-impact dimension,'. The model categorizes these dimensions into four types: support, reliance, alignment, and alliance. The FORT model can also be used to represent both static and dynamic types of client-vendor relationships, and consequently can be utilized to examine the movement of changing IS/IT outsourcing relationships over time (Ho and Atkins 2006). The FORT framework demonstrates the relationship between the public organization and the vendor. Figure 1 represents the basic concept of the FORT model.

In this study, the extent-of-substitution dimension in Figure 1 explains how much in-house operations are transferred to the vendors that carry out the IT outsourcing project. The strategic- impact dimension in Figure 1 represents the importance of the outsourced IT project for competitive positioning and its long-term strategy. The 'support' cell in Figure 1 corresponds to the traditional IS/IT vendors' service and the most primitive type of outsourcing relationship. Vendors are usually restricted to non-core IT activities, and the size of the contract is small. In such relationships, the role of vendors is limited and hence in-house retention tends to be more prevalent than outsourcing. A support relationship involves low coordination costs, and monitoring the relationship is easy because the extent of substitution by the vendors is low.

Outsourcing in the 'reliance' cell requires more commitment from vendors and clients. Therefore, the length of the contract is longer than in the support cell. IT functions outsourced here are mostly non-core activities, and cost reduction is one of the major motivations.

Outsourcing in the 'alignment' cell enables organizations to obtain vendors' technical expertise on a project or on 'on-demand' basis (Ho and Atkins 2006). Examples of the 'Alignment' cell are IT consulting, technical supervision for IT planning and design, and system conversion. The vendor's impact lasts longer than in the support cell. The main difference from support type is that the vendor here is involved with more strategic IT functions.

The 'alliance' cell evolves based on mutual relationships. The vendor not only substitutes for in-house IT operations but is also completely responsible for strategic IT activities of the client. The term of the contract is usually longer than in the other types of relationships. Strong commitments from vendors and clients are required here. In such relationships, the client-vendor work together as strategic partners due to the presence or establishment of common goals (Ho and Atkins 2006).

METHOD

Due to the distinct characteristics of public organizations this study presumes that different types of IT outsourcing relationships would yield different results in terms of outsourcing success. Kishore et al. (2003) implies that the risk level of the outsourcing decision should be different with respect to different positioning through movement on the FORT matrix. With this observation the following hypothesis is proposed:

IT outsourcing success in the public sector will be different with regard to four different types of outsourcing relationships.

This study investigates the type of relationships between government organizations and vendors that have carried out IT outsourcing project. First, background information of various IT outsourcing projects, initiated by the Korean government since 2000, were collected. Then research meetings were held with IT managers responsible for managing IT outsourcing projects in the Korean government organizations. A total of 178 responses were collected from 56 different organizations. Among the 178 projects, the largest size of a project in terms of the contract amount is about 18 million US dollars for constructing a new integrated data center for E-government. The smallest project is about USD 5,500 for redesigning an E-government web site for a local government. The average contract amount is about USD 1.48 million. The longest contract duration is of 84 months, and the shortest is of 1 month. The average duration of the sample is 9 months.

Using a formulated questionnaire, IT managers of the organizations were asked three questions concerning IT outsourcing success: (1) satisfaction with the result of the outsourcing project; (2) usefulness of the result; and (3) intention to continue the outsourcing relationship with the vendor (Koh, Ang, and Straub 2004; Saunders, Gebelt, and Hu 1997). Then, in order to identify relationship type, they are also asked questions regarding extent-of-substitution and strategic-impact, as discussed earlier. Based on their responses, each IT outsourcing project is classified into four different partnership categories. Table 1 summarizes the results.

ANALYSIS

To test the differences between relationship types that are observed from the questionnaire a Chisquare analysis is conducted. Significant differences between the different types of relationship were found at the level of 0.001 (χ2 = 136.337, df = 3, expected frequency = 43.8). This result shows that 'support' and 'reliance' types of IT outsourcing relationships are less frequently practiced, whereas 'alignment' and 'alliance' types are more frequently practiced in the public sector. Interestingly only two cases of 'reliance' type relationship are observed in this sample. This observation can be explained by (Nam et al. 1996) findings that reliance type is frequently observed when the motivation of IT outsourcing is cost reduction. In this sense, the result in Table 3 is consistent with (Nam et al. 1996) because data used in this study are collected from non-profit government organizations.

Mean values of the dependent variable (i.e. success) of each relationship types are compared with each other in order to identify which relationship type is most likely to succeed in the public sector. An ANOVA and Scheffe test, as post-hoc analysis are applied to statistically compare the group differences. An ANOVA is chosen as the statistical test because this study is required to compare the mean value of IT outsourcing success of more than two experimental groups. Scheffe's test is used as post-hoc analysis to determine the significant differences between the groups' mean value in an analysis of variance setting. However, due to the small sample size, the 'Reliance' type is eliminated from the analysis in order to generate reliable results. These results are shown in Table 2.

As shown in Table 2, there are statistically significant differences between three types of relationships. The 'alliance' type shows the highest mean value (3.818), followed by the 'alignment' type (3.548) and the 'support' type has the lowest mean value (2.641). This finding shows that when extent of substitution and strategic impact is high (i.e. alliance), the IT outsourcing project is more likely to succeed than the other two types of relationships. In contrast, when extent of substitution and strategic impact is low (i.e. support), the IT outsourcing project is less likely to succeed than the other two types.

The FORT model classifies IT outsourcing relationships into four different types (2 2). This study divides the FORT model into 16 grids (4×4) to explore the association between relationship types and IT outsourcing success in detail. Each IT outsourcing project is then allocated to the grid based on the answers from the respondents. The number of observations of each grid and its mean value and standard deviation is illustrated in Figure 2.

As shown in Figure 2, the highest mean value of IT outsourcing success (4.022) is observed in the P4 gird. The lowest mean value (2.167) is observed in P1. Kishore et al (2003: 89) argues that 'IT outsourcing partnerships are not static; they are likely to change and evolve over time due to changes in the external environment and in client's internal requirements'. In their longitudinal study, changes in outsourcing relationship policy have been observed, most of which move from bottom to top and from left to right, across and within cells of the FORT framework. It is also emphasized that the wrong relationship decisions through the positioning of movements may lead to serious risks to the organization. What we find is that in order to accomplish the organizational goals, the organization keeps changing the policies or strategies with respect to both the 'extent of substitution by the vendor' and the 'strategic impact of the outsourced IT' dimensions. At the same time the organization tries to avoid potential risks from the IT outsourcing relationship. Therefore, it is necessary for the public organization to find out how to approach the best practice of relationship before changing policies or making new decisions on IT outsourcing projects.

Thus, we have attempted to provide an example illustrating how to approach the best practice from a certain point on the FORT framework in order to minimize the risk of IT outsourcing failure. First, it is assumed that due to rigid and conservative structures of the government organization, the relationship movement can be performed only into adjacent grids on the 16-grid FORT framework when an IT outsourcing project is planned. In this regard, it will be very difficult for the government organization to radically change their policies or habitual practices. For an example, P1 is set as a starting point due to its lowest success score and then t-tests is performed on P1 with adjacent grids to find the way of increasing success level. After ttests among adjacent grids of P1, P2 is identified as a grid for the next movement. The same procedures are applied to the gird of P2, and subsequently P3 is identified as the next movement. Then P4 is selected as the next step after P3. However, no adjacent grids of P4 shows higher success scores than P4 itself. Thus, the grid of P4 is set as the best practice because projects of P4 show the highest IT outsourcing success scores from the sample, as shown in Figure 2. The best practices of IT outsourcing in public sector is found in the grid P4. This best practice can be achieved when strategic impact of the outsourced IT (the x-axis) is high and the extent of substitution by the vendor (the y-axis) is also high but not fully substituted. This finding can be explained in terms of fear of loss of control and the conservative organizational culture of the government organization.

CONCLUSIONS AND DISCUSSION

The goal of this study was to identify best practice in IT outsourcing relationships in the public sector. It was found that alliance type insures the best practice of IT outsourcing in the public sector due to its highest success rate than the other relationship types. This finding is reasonable in the sense that a public sector IT project is more likely to be strategic (Figure 2) in nature. Strategic and complex IT outsourcing projects are more likely to have a larger budget and a longer time horizon. Such projects will tend to receive more attention from both vendors and IT managers, fostering a better relationship. On the other hand, projects with a less strategic impact usually fall into a support type of relationship. In this case, vendors are usually restricted to noncore IT activities, and the size of the contract is smaller. IT outsourcing in this type of relationship shows a low success rate.

IT managers in the public sector should consider the constraints and the difficulties in moving from one type of partnership to another. For example, IT outsourcing in the support type should not try to jump directly to the alliance type, as this would require a higher budget and more time, issues which are not likely to be solved in a short time in the public sector. Rather, IT managers should consider stepwise multiple movements from one type to another. Thus, it is necessary to have a clear plan for their future movement. Since often in-house development is not regarded as a feasible solution for the public sector, movement from a low to a high level of relationship is not avoidable. Public sector IT outsourcing should be considered more as management of a long term relationship with service providers rather than as a simple contract for IS commodities, since it is usually more unique, complex, and strategic in nature. These findings can be explained in terms of conservative organizations culture of public sectors like inflexibility in bidding process, complexity of the legislations to undertake, complexity in decision making process due to high interdependence and wide variety of stakeholders with different vested interests (Vilvovsky 2008).

There are some limitations in this study that suggest opportunities for future research. First, this research is based on research at a point in time. However, as outsourcing relationships change over time future longitudinal research can be considered. Second, the sample of this study is limited to Korean public sector organizations so caution is needed when generalizing the findings. Future research may extend this to different settings, cultures, bidding processes and IT adoption rates.

This study is the first of its kind to explore the findings of the best practice of IT outsourcing in terms of relationship management in the public sector, which it is hoped furnishes useful guidelines for practitioners. This study also expands the IT outsourcing relationship literature in the public sector and employs the FORT model. In a situation where organizations are concerned on how innovation can be promoted or encouraged this study identifies the relationship based IT outsourcing practice as an innovation because it is a new practice in the public sector environment and provides fruitful results. As the nature of IT outsourcing practice has evolved as the one based on relationships it is very critical for the practitioners in the public sector to have an understanding of this innovation of relationship based practice for the success of any IT outsourcing projects.

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Received 2 February 2009 Accepted 14 May 2010

Author affiliation:

JUNGHOON MOON

Korean Advanced Institute of Science and Technology (KAIST), Yuseong-gu, Daejeon, Republic of Korea

BOBBY SWAR

Korean Advanced Institute of Science and Technology (KAIST), Yuseong-gu, Daejeon, Republic of Korea

YOUNG CHAN CHOE

College of Agriculture and Life Sciences, Seoul National University, Seoul, Republic of Korea

MIRI CHUNG

College of Agriculture and Life Sciences, Seoul National University, Seoul, Republic of Korea

GU HYUN JUNG

Gyeonggi Province Agricultural Research & Extension Services, Hwaseong-si, Gyeonggi-do, Republic of Korea

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