Should We Go Our Own Way? Backsourcing Flexibility in IT Services Contracts.

Author List: Benaroch, Michel; Dai, Qizhi; Kauffman, Robert J.;
Journal of Management Information Systems, 2010, Volume 26, Issue 4, Page 317-358.
The emergence of new service science approaches to business problems in information technology (IT) services offers new, unusually relevant insights for the senior management of vendors in this business area. This research examines how service-level agreement contract flexibility should be designed when the technological and business market environments result in volatility of demand, based on an understanding of related changes in the cost drivers that underlie IT services contracts. Our approach draws on a blend of well-known methods from financial economics--the real option pricing method and the contingent claims analysis method. In particular, our research examines a setting in which a vendor provides IT services to a client according to a prenegotiated IT services contract in the presence of demand volatility. We analyze the motivation of and value consequences for a vendor that offers the client the flexibility to opt out of the contract. For example, the client might switch to another vendor, or backsource and provide its own services internally. Our core results offer important foundational thinking for how to specify various forms of IT service-related flexibility in terms of put and call options from the point of view of an IT services vendor, so that their value and exercise timing can be estimated. We show that the client firm's demand trigger value for deciding when to backsource its IT services varies, and it depends on the degree of demand volatility as well as the usage-based fees charged by the vendor. Working from our modeling approach, we also are able to characterize the extent to which a vendor can benefit from bearing the costs of making a backsourcing flexibility option available to its client.
Keywords: contingent claims analysis; demand trigger value; demand uncertainty; financial economics; IT services; outsourcing; real options; service science; valuation; vendors; volatility
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List of Topics

#112 0.137 services service network effects optimal online pricing strategies model provider provide externalities providing base providers fee complementary demand offer derive
#47 0.128 outsourcing vendor client sourcing vendors clients relationship firms production mechanisms duration mode outsourced vendor's effort activities in-house managing technology domestic
#44 0.109 approach analysis application approaches new used paper methodology simulation traditional techniques systems process based using proposed method present provides various
#143 0.102 value business benefits technology based economic creation related intangible cocreation assessing financial improved key economics assess question created create understanding
#267 0.092 options real investment option investments model valuation technology value analysis uncertainty portfolio models using context intuitive managerial regret uncertain case
#21 0.074 research information systems science field discipline researchers principles practice core methods area reference relevance conclude set focus propose perspective inquiry
#70 0.068 contract contracts incentives incentive outsourcing hazard moral contracting agency contractual asymmetry incomplete set cost client parties examine effort structures double
#168 0.061 firms firm financial services firm's size examine new based result level including results industry important account does suggests characterize limited
#54 0.057 approach conditions organizational actions emergence dynamics traditional theoretical emergent consequences developments case suggest make organization point outcomes recent trajectory claims
#165 0.053 uncertainty contingency integration environmental theory data fit key using model flexibility perspective environment perspectives high conditions processing examine issue uncertain