Strategic IS Sourcing and Dynamic Capabilities: Bridging the Gap

S. Balaji
Doctoral Student
Information Systems Department
Indiana University, Bloomington
Email: bsankara@indiana.edu
Susan A. Brown
Assistant Professor
Information Systems Department
Indiana University, Bloomington
Email: suebrown@indiana.edu

Abstract

Information Systems (IS) sourcing consists of the
delegation of all or any part of the technical resources,
the human resources, and the management capabilities
associated with providing IT services to the external
vendor. This can range from insourcing to domestic
outsourcing, offshore outsourcing, nearshore outsourcing
and any such variants. The sourcing organizations
(clients) increasingly look at the capabilities of the vendor
as a benchmark for the quality of the service rendered by
the vendor. The capability maturity model is one such
preferred scale for assessing the capabilities of the
vendor. However, such a capability model does not exist
for a client which ventures or is about to venture in a
sourcing relationship. The purpose of this paper is to
isolate the key IS capabilities that a client could develop
to succeed in a sourcing relationship. This represents the
first step in developing a client sourcing capability model.


1. Introduction

The nature of Information Systems (IS) sourcing issues
has experienced significant changes over the years. As
practice has evolved from a simple make-or-buy decision
to complex contracts and partnerships, sourcing research
has endeavored to maintain relevance ([16],[17],[18]).
Different perspectives have been applied by researchers to
understand the sourcing decision, the key among them
being production and transaction cost economics [2],
resource-based views and resource-dependence views
[32], and discrepancy theory [30]. The rationale for
applying these theories to understand IS sourcing lies
primarily in the fact that IS sourcing is increasingly seen
as a powerful option for improving internal efficiencies of
a firm. According to the core competency theory [16], a
firm attains sustained competitive advantage by
concentrating on the core business activities. By sourcing
other activities, a firm can more effectively use its
resources to focus on its core competencies.
Strategic perspectives yield three dimensions of the IS
sourcing decision: degree of integration, allocation of
control and performance period [17]. These dimensions
provide a framework for the client firm to negotiate with
the vendor on the parameters of their relationship.
However, the choice of vendor is also based on the
capability maturity model (CMM) level of the vendor [9].
The CMM assesses the maturity level of a firms
processes, with 5 being the highest. Process maturity is
gained by years of experience in the field [9].
As vendor capability for a sourcing project or a
relationship is deemed important by the client, it seems
equally important to think about client side capabilities
for managing such a relationship. These capabilities are
different from traditional organizational capabilities that
a firm may possess [24]. These capabilities can be
considered IS capabilities [8]. As strategic theories
suggest ([22], [35]), to gain significant competitive
advantages from a sourcing relationship, it becomes
imperative for the client to focus and develop these
capabilities. Thus, the research question this paper intends
to address is, What are the necessary client-side
capabilities for a successful IS sourcing endeavor?
This paper applies the dynamic capabilities perspective
(DCP) ([6]; [31]) as the foundation to derive the client-
side capabilities for sourcing. DCP is a recently
developed theory focusing on the capabilities that render
dynamism to a firm in a rapidly changing environment. It
differs from the resource-based view in that it promotes
the idea of a firm as a bundle of capabilities instead of
viewing the firm as a bundle of resources. As Eisenhardt
and Martin [6] note, by assimilating these capabilities, a
firm can restructure existing resource configurations to
achieve superior market position.

2. Strategy-Based Theory of the Firm

Table 1 provides an overview of key strategy-based
theories of the firm, highlighting those that have been
applied in the IS literature. The first column identifies the
theory, while the other columns of the table represent the
key attributes of each theory. Business value refers to the
value attained by the firm as a result of acquiring a
resource or a capability, which could be monetary or other
benefits. Firms position refers to how the firm positions
itself in the market. Type refers to the degree to which
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the capability is core or central to the business. Finally,
imitability refers to whether the theory assumes imitation
potential by competitors.
Each of the four models presented in Table 1 can be
used to understand a firms sourcing decision. Porters
five-forces model ([23]; See also [24]) explains how a
firm takes a defensible position with respect to the five-
forces of the market, whereas the other theories explain
how a firm takes an aggressive stance to seize competitive
advantage from competing firms. The underlying
assumption in RBV is that by acquiring resources that
have VRIN attributes (i.e., Valuable, Rare, Imperfectly
imitable, and Non-substitutable), a firm acquires direct
business value [32]. The core competency theory builds
on the idea of core capabilities. The DCP views
capabilities as levers to modify resource configurations,
and so the business value obtained as a result is indirect
(through changed resource configuration). RBV and
DCP, however, build on non-core capabilities
capabilities that aid in the running of business, but not
necessarily central to it [36]. RBV is founded on non-
imitable resources, whereas DCP assumes imitable
capabilities [36].
The resource-based view of the firm has been
successfully applied in explaining a firms outsourcing
decision. The lack of resources, or resource-gaps, that a
firm possesses can be rectified by acquiring resources
from outside the firm boundaries using sourcing
arrangements [32]. However, the acquisition of resources
from outside does not, by itself, guarantee competitive
advantage to the firm. In fact, other arrangement-related
factors such as service quality and partnership are deemed
important in attaining strategic, economic and business
benefits from a sourcing arrangement [10]. Thus, as
argued from an alliance perspective [5], if the underlying
theme for the decision to outsource is to achieve sustained
competitive advantage, the fundamental driver for such an
advantage must be situated not in the resources acquired,
but in the competencies that are at a higher level of
abstraction from resources. These competencies are
referred to as dynamic capabilities ([6], [31]).
Using the RBV, Mata et al. [20] hypothesized that five
key IS drivers: customer switching costs, access to
capital, proprietary technology, technical IT skills, and
managerial IT skills lead to sustained competitive
advantage. However, only the hypothesis on managerial
skills was supported. Bharadwaj [3] adopted RBV to
provide a similar operationalization of IT resources
consisting of IT infrastructure, Human IT resources and
IT-enabled intangibles. The IT capability is derived by the
ability of the firm to assemble, integrate and deploy these
resources effectively. Thus, the capability perspective in
Bharadwaj [3] can be viewed as espousing the dynamic
capabilities perspective, in addition to isolating the
resource-base using RBV.
Resources and capabilities form the basic tenet for
understanding the position of a firm in an industry ([22],
[35], [36]). Yet, resources and capabilities are notably
different from each other ([11], pp. 343). Resources
refer to physical (e.g., IT assets), human (e.g.,
technological know-how) and organizational (e.g.,
culture) capital, essentially representing things that the
organization possesses [26]. Capabilities, on the other
hand, refer to the firms capacity or ability to deploy
valued resources, usually in combination or in co-
presence ([11], pp. 343; See also [1], [36]). Capabilities
are path-dependent and develop over time ([6]), and thus
represent organizational potential.
It is important to recognize that resources can also be
shared between firms, at the inter-firm level [5]. For
example, in an interorganizational arrangement such as
sourcing, which involves a client and the vendor(s), the
resource-base extends beyond the client firms boundaries
and is shared with the vendor. The idiosyncrasies in the
client-vendor relationship, yield relational rents to the
participants ([17], [13]). In support of this perspective,
Zajac and Olsen [39] argue, Both parties use the
interorganizational strategy to establish an ongoing
relationship that can create value that could otherwise not
be created by either firm independently (as quoted in [5])
which leads to the premise that creation of value in a
sourcing relationship is contingent on the type of
resources that are being shared between the firms. Thus,
applying Ross et. als [26] IS resources framework to the
sourcing context: the human IT resources refer to the
technical and managerial skills of the employees involved
in the outsourced project, the IT infrastructure refers to
the set of project-related themes and the relationship
resource refers to the formal and informal partnering
between the firms. The combination of such relation-
specific resources forms the basis for competitive
advantage in an inter-organizational arrangement [5].
Adopting a configurational perspective, Lee et. al [17]
identify three congruent patterns, or gestalts, of IT
outsourcing strategies that firms adopt to gain sustained
competitive advantage, namely: independent, arms
length and embedded strategies. Each gestalt differs from
another in terms of the degree of interaction, control and
duration. Thus, by applying various strategies [17] for
managing these resources, client firms extract competitive
advantage from the sourcing arrangements. We classify
the capabilities that address managing human, IT and
relationship resource into: vendor management, project
management and process management.
Capabilities provide the basis for reconfiguring
resource allocations [36]. In the context of sourcing,
resources essentially translate to the inter-organizational
assets that are part of the sourcing arrangement. Inter-
organizational assets can range from relation-specific
assets such as transaction-specific know-how to
knowledge-sharing routines, and are sources of relational
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capital leading to competitive advantage ([5],[12]). We
argue that by acquiring management capabilities to
deploy such sourcing-related resources, a client firm can
attain significant competitive advantage from a sourcing
arrangement. A case for considering vendor management,
process management and project management as the three
capabilities to be developed by the client is presented
next.

Table 1. Strategic theories of the firm


3. Capabilities for IS Sourcing

Figure 1 provides a DCP-based framework for IS
sourcing. As shown in Bharadwajs [3] study, and raised
by Sambamurthy [27] and Wheeler [36], the DCP is an
equal or better predictor of sustained competitive
advantage of a firm in the context of IS. This is because,
capabilities provide the leverage for reconfiguring
resource allocations, which in turn leads to competitive
advantage [36]. Thus, we apply DCP to understand the
key capabilities necessary for successful IS sourcing in
the client firm.
Previous research suggests that some of the IS
capabilities required by a client include: contract
facilitation and buying, informed buying, and vendor
management [8]. We extract these capabilities into
broader segments and extend them to include additional
related capabilities. These additional capabilities have
been conceptualized based upon the latest trends and
developments in the field of IS sourcing and on research
efforts in this direction.

3.1. Vendor Management

Vendor management is defined as the ability of the
client firm to wield significant control over its vendor(s).
It reflects the ability of the client firm to control,
coordinate and maintain the current vendor relationship,
while at the same time, building replacement strategies in
case of changes in sourcing preferences. In vendor
management, the client firm looks beyond existing
contractual agreement and explores long-term potential
for vendors to create win-win situations [8], focusing on
the two essential elements of a successful relationship:
partnership (Smith et al.) and service quality [10].
Vendor Management is a dynamic capability because
it renders a firm with the needed leverage to switch
between vendors, effect changes in partnerships, and
impose constraints on the vendor-behavior thereby
potentially changing the dynamics of the relationship.






Evidence from practice suggests that the capability of
the vendors (in terms of CMM) has grown steadily and
the products or services delivered have become quite
standardized. The key differentiation among competitors
of the firm will lie in managing the vendor, rather than in
the products or services obtained from the vendor.
In order to achieve sustained competitive advantage
from a sourcing relationship, it is essential to control the
costs incurred in the initial stages of the relationship with
the vendor. These are referred to as transition costs that
include, but are not limited to, vendor selection [34],
frequent travel between the client and the vendor teams,
fixing service agreements terms, isolating key aspects of
the agreement, and fixing costs. Transition costs can be
considered to form part of the relation-specific
idiosyncrasies [5] between the client and vendor. In
practice, organizations typically select an established
vendor to partner with, to control for such transition costs
[17].
The ability to manage multiple vendors at the same
time is a key aspect of a firms ability to keep transition
costs under control. Evidence from practice suggests that
current trends in outsourcing are moving toward a multi-
vendor arrangement, in which services from multiple
vendors will be pooled together either by the client firm
or by a third-party vendor. As reported in practitioner
articles, the multiple vendor arrangement is preferred
when the specificity of the domain-expertise of the
vendors far exceeds the overall expertise required for the
project. One such recent arrangement has been reached
between Kodak, IBM and WIPRO, in which IBM will
Theory Business
Value
Firms
position
Type Imitable Reference in IS literature
Porters Five Forces
Model [23]
Direct Defensible - -
Resource-Based View
[35]
Direct Aggressive Non-core No [3], [26], [28]
Core Competency
[24]
Direct Aggressive Core No
Dynamic Capabilities
[31]
Indirect Aggressive Non-core Yes [27], [36]
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provide the logistics and WIPRO will provide offshore
implementation capabilities for Kodak. By developing a
capability to control transition costs and manage multiple
vendors, client firms obtain the flexibility to negotiate
optimal vendor configurations and replacements to
existing vendor relationships, if need be. We define this
capability collectively as partnering capability.

Proposition 1: Firms with superior partnering
capability will consistently reduce transition costs in a
sourcing relationship, whether through single or multi-
vendor arrangements, thus freeing those resources to be
allocated elsewhere in the firm, and contributing to the
firms ability to attain competitive advantage.

A client firm exercises formal and informal forms of
control over a vendor in the context of a sourcing
relationship. It is important to note that the influx of
offshore outsourcing has yielded a new dimension to
informal controls, namely culture controls [4]. Numerous
studies have focused on the differences in cultural
perceptions and the impacts they have on projects (e.g.,
[7]). These controls together form the portfolio of controls
([15], [4]) and have been shown to improve the overall
success of the vendor-client relationship. The client and
the vendor firms are more likely to make investments in
relation-specific assets when they have created effective
safeguards ([5], pp. 864; See also [37]). Also, as the
length of the relationship increases, the level of trust
increases, the inter-firm processes become routinized, and
the emphasis on the nature of controls shifts from being
formal to more informal [12]. Thus, developing the
capability to exercise a portfolio of controls, helps cement
the current relationship with the vendor, thereby allowing
the client to reap relational rents (Ex: relation-specific
assets) ([5],[13]) and subsequently to obtain competitive
advantage. We define this capability of a client to exercise
the appropriate form of control over a vendor as control
capability.

Proposition 2: Firms with superior control capability
will exercise a portfolio of control mechanisms consisting
of formal and informal controls to best use organizational
resources to obtain competitive advantage from a
sourcing relationship.
P2a: As the length of the client-vendor relationship
increases, the emphasis on informal controls increases and
that of formal controls decreases.
P2b: As the perceived differences in terms of national
culture between the client and the vendor is high, the
extent of cultural controls increases.

3.2. Project Management

Project management is defined as the way in which
outsourced projects are managed by the client firm. Even
though researchers have debated for and against
considering project management as an IS capability (e.g.,
[8]), we consider project management to be part of the IS
capability because it consists of various stages, such as
contract building and team selection, thus putting the tacit
knowledge inherent in the IS department to use [21].
Project management is a dynamic capability in IS
sourcing since the nature and type of contracts should
reflect the evolving changes in the technology and
environment. For example, a recent Gartner study
indicates that contracts drawn with companies in India
need to be less concerned about infringement of rights
than in countries like Russia. Two aspects of project
management are considered in this paper: contract
facilitation and building and informed buying and
resource allocation (e.g., team members). These are key
capabilities that must be built by a client firm to attain
competitive advantage from a project arrangement with a
vendor ([8]). By developing these capabilities a client
firm can wield considerable influence on the way a
project is implemented and can reap maximum benefits
out of the same.
The capability of the client and the maturity of the
vendor teams are important criteria when deciding the
structure of the team. Previous research has documented
the power and politics that come into play when a new
system is being built [19]. The scenario of outsourcing is
just another instance of the same tussle, wherein the
importance of the client team members could be
undermined by the presence of the vendor team members.
So, assigning team members and selecting the appropriate
delivery model are key aspects of IS sourcing capability.
In the following proposition, superior and appropriate
follow similar definitions as in proposition 2.
Delivery models are those that are adopted by a vendor
firm to decrease the number of team members assigned
for a project while at the same time ensuring efficiency.
The offshore development of a project has ushered in a
multitude of delivery models such as offshore
development, onshore development, onsite development,
global development and so forth. The nature of the project
dictates the type of delivery model chosen.
Contract facilitation and building consists of activities
that ensure success of existing contracts for IS services
([8]). Feeny and Willcocks [8] report one of their
interviewees as noting, The users have been bitten a few
times when they have dealt directly with suppliers (pp.
14). This observation highlights the importance of
contract facilitation as a capability to distance users from
potential threats due to ill-equipped vendors as well as
those who fail to fulfill commitments. More recently, the
nature and type of contracts that firms typically selected
during offshore software development were investigated
[9]. The two types of contracts considered in Gopal et. al
[9] were time and materials contracts and fixed price
contracts. Firms must possess the capability to assess the
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types of contracts that are appropriate for a given scenario
and choose accordingly. Failure to do so can have a
negative impact on organizational resource
configurations, and ultimately on competitive position. In
the following proposition, superior contract building
capability refers to the extent of knowledge about the
needs of the project and how they can be matched in the
contract and appropriate refers to the choice of either
the time and materials contract or the fixed price contract.

Proposition 3: Firms with superior contract building
capability will choose the type of contracts that facilitate
optimal resource configurations.

3.3. Process Management

Process management can be defined as the way in
which key processes in an organization are performed,
maintained and managed for a sustained period of time.
Process management is concerned with such aspects of
relationship management as Knowledge-Integration
processes and total quality management (TQM)
processes.
Promoting quality in systems development as a series
of deep, interrelated studies on specific qualities or
constructs in a variety of related fields, organizational
change and TQM were unified into a single model in
Ravichandran and Rai [25]. The relationships suggested
by this model may aid managers and practitioners in
properly and effectively promoting quality in their
systems development efforts. For example, mandating
stakeholder participation from top management will
ultimately be ineffective if the proper infrastructure does
not exist to promote it.
TQM starts with the organization realizing the
importance of promoting quality management right from
the top level to the grass-roots level of IS development.
This applies not only to the projects that are undertaken
within-company, but also in sourced projects. TQM is a
process capability that can be exploited in all kinds of
projects and so forms part of the process management
genre.
Knowledge integration is defined as the process of
absorbing knowledge from external sources and blending
it with the technical and business skills, know-how, and
expertise that reside in the business and IS units of a firm
([33], [38]). Application of knowledge to the IS
development process is a socio-technical process
involving multiple objectives of various project
stakeholders [14]. Coordination of knowledge is often
challenging because much of the pertinent knowledge is
dispersed across organizational boundaries both within
and outside an organization. Hence, knowledge
integration can be classified along two dimensions:
external knowledge integration and internal knowledge
integration [33]. The extent to which a firm succeeds in
integrating business and technical knowledge with its
vendor makes it successful in the relationship.

Proposition 4: Firms with superior knowledge
integration capability will succeed consistently
1
in their
project implementations, as measured by resulting
resource configurations and the efficiency and
effectiveness of the implementation.

4. Discussion

The preceding sections have highlighted the type and
nature of capabilities that need to be built by a client firm
in order to maintain and sustain competitive advantage
from an IS sourcing arrangement. These capabilities can
be used to build a client-side capability scale. The study
of capabilities in the IS field is very important due to the
growth in the centrality assumed by IS in an organization.
IS sourcing decisions in the past were taken purely based
on economies of scale and scope, but recent trends
indicate that they are increasingly based on the strategic
orientation of the firm [17].
Researchers can benefit from this framework by
examining the antecedent conditions of each IS capability.
This is similar to the approach taken in Tiwana et al. [33]
to expand knowledge-based antecedents of IS
development capability. Research can also benefit by
using this paper as a foundation for identifying additional
capabilities which may be more or less influential in IS
sourcing.
Practitioners can benefit from this framework, by
developing these capabilities in their firms. This provides
motivation for firms to do an introspective study of their
own capabilities, in order to find out the salient pieces
that are present and absent in their organization, thereby
avoiding those relationships with vendors that are
troublesome. For example, in order to have a successful
relationship with an offshore vendor, cultural gaps need to
be addressed. If this capability is not fully developed in a
client, due to any number of factors, domestic outsourcing
might be a better option. Thus, assessing the set of
capabilities as provided in this paper is of benefit to both
academics and practitioners alike. In the long run, these
capabilities have the capability to evolve into a more
formal and rigorous set of guidelines for client
organization.

5. Conclusion

This paper argues for a different perspective of the
resources and capabilities that have been addressed in the
context of IS research. Specifically, this paper contends

1
Since these are processes, their impact can only be
assessed over a period of time.
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that a dynamic capabilities perspective offers the greatest
opportunity for understanding IS sourcing issues. The
purpose of this paper has been to focus attention on the
important aspects of IS capabilities and to provide
insights into how existing theory on capabilities could be
matched to the same. This paper provides the basis for
future research that can examine these capabilities in
isolation and in totality, to improve our understanding of
the locus of competitive advantage of a firm.
Ultimately, as the capabilities in the field of IS sourcing
are isolated, they can be used to develop a maturity scale
for the capability of the client.

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Proceedings of the 38th Hawaii International Conference on System Sciences - 2005
7

Figure 1: Conceptual Model








Firm-level
Competitive
Advantage
Capabilities
Vendor
Management
Project
Management
Process
Management
Resource
Configurations
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Proceedings of the 38th Hawaii International Conference on System Sciences - 2005
8