Flexibility and Cost in Information Technology Outsourcing: Balancing Opposing Goals

The growth in the importance of IT outsourcing arrangements combined with the rate of failure of such arrangements makes it imperative to address issues of contracting in the IS literature. In this work, we examine the contract directly and show how the costs stipulated in the contract affect the nature of the outsourcing relationship. The work develops a mathematical model of IT outsourcing contracts to explore the relationship between costs of the anticipated IT needs and the costs of additional resources in the face of changing IT needs. The model exposes the underlying tension between the baseline cost of an anticipated bundle of services and the flexibility to modify that bundle in response to changing environmental conditions. Additionally, we draw testable propositions about the relationship between contractually specified costs of IT services and the costs inherent in both client and vendor production of IT services. The model shows that client can never get the same cost structure as the vendor. Rather the client achieves contractually specified cost structure that will be a compromise between vendor and client costs. The model also proposes that contractual flexibility is directly related to the contractually specified cost of the anticipated bundle of IT services. Thus, contracts that stipulate a very low baseline cost for the anticipated bundle of IT services are less flexible so that changes beyond the baseline are more expensive.