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Global Multisourcing Strategy: Integrating Learning from Manufacturing into IT Service Outsourcing Ning Su Richard Ivey School of Business, University of Western Ontario 1151 Richmond Street North, London, Ontario N6A 3K7 Canada [email protected] Natalia Levina Stern School of Business, New York University 44 West 4th Street, New York, NY 10012, USA [email protected]

ABSTRACT “Multisourcing” is emerging as an important strategy in today’s global information technology (IT) service outsourcing arena. The existing literature on IT services provides only limited understanding of this phenomenon. However, in the manufacturing domain, a similar concept, supply base management, has been extensively examined, especially in the operations management (OM) literature. In this study, we integrate related research in service and manufacturing to investigate how to successfully pursue IT service multisourcing. Specifically, we first conceptualize a firm’s multisourcing supply base along the dimensions of breadth and depth, and theorize about the impact of these two dimensions on outsourcing outcome. Second, based on this theoretical framework, we analyze four configurations of multisourcing supply base. Finally, we use case studies of two global financial services firms to illustrate the evolution of these configurations and identify patterns of multisourcing strategy in IT services. Keywords: IT Outsourcing, Multisourcing strategy, Supply base, Service supply chain

1 Electronic copy available at: http://ssrn.com/abstract=1794544

1.

I$TRODUCTIO$

“Multisourcing” is emerging as an important strategy in today’s global information technology (IT) service outsourcing arena [1]. Multisourcing is generally understood as combining IT and business services from a select set of internal and external service providers to achieve optimal outcome [1]. The key to the success of this strategy is combining services provided by multiple vendors to gain a competitive advantage. The rise of multisourcing is driven by firms’ increasing need to achieve cost efficiency, flexibility, and quality in a rapidly-changing global market [2] [3], and is precipitated by the expiration and renegotiation of many firms’ legacy outsourcing contracts [4]. Multisourcing brings firms both opportunities and threats. On one hand, using multiple vendors may lead to significant benefits [5]; on the other, it may challenge firms’ existing managerial capabilities and operational models [1] [6]. In the past, many large firms developed relationships with multiple vendors for a particular business function due to historic reasons such as mergers and acquisitions and decentralized decision making in vendor selection. Increasingly, however, IT managers have started thinking of using multiple vendors as a strategic move. The existing literature on IT outsourcing offers some examples of multisourcing contracts [7] [8] [9], but only limited theoretical understanding of such strategies. However, in the manufacturing domain, a similar concept, “supply base management,” has been extensively analyzed, especially in the operations management literature. Moreover, in manufacturing, there is a trend opposite to multisourcing in services, namely, supply base consolidation or reduction [10]. It is generally believed that decreasing the number of suppliers and building deep supplier relationships are among the key best practices that differentiate the market-leading Japanese automakers Toyota and Honda from their less successful American counterparts [11] [12].

2 Electronic copy available at: http://ssrn.com/abstract=1794544

In this study, we integrate related research on multisourcing in both information systems (IS) and operations management (OM) literature, and develop a theoretical model of the tradeoffs associated with the use of multiple vendors for IT services. Specifically, we first characterize a firm’s multisourcing supply base along two dimensions, breadth and depth, and theorize about the impact of these two dimensions on different aspects of outsourcing outcome including cost, flexibility, resource, quality, and risk. We then build on this theoretical framework and develop a conceptual map of four configurations of multivendor supply base in global multisourcing strategy. Finally, we use case studies of two global financial services firms to illustrate how these configurations were implemented and had evolved in real business settings and identify patterns of multisourcing strategy in IT services. 2.

RELATED LITERATURE

In this section, we review concepts related to using multiple vendors in IT services and manufacturing, and identify different aspects of outsourcing outcome. 2.1.

Multivendor Sourcing

In the IT service domain, the first detailed descriptions of multivendor sourcing discuss an arrangement where there is one outsourcing contract but multiple service suppliers [7] [8] [13]. Such a strategy is most suitable when the IT work to be outsourced has a large scale and when the firm wants to reduce the risk associated with supplier dependence, while the managerial overhead created by multivendor relationships is the key limitation [8]. This limitation seems to be diminishing in recent years as firms realize the need to invest in internal sourcing competence and create organizational structures and tools to effectively manage vendors and execute sourcing strategy. The idea that firms have to build sourcing capabilities that can later be used to manage multiple vendors was made popular, in particular, by a recent book written by Gartner’s

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consultants [1]. The book advocates the use of multiple vendors for certain types of services as part of a sourcing strategy that is termed “multisourcing”, that is, “the disciplined provisioning and blending of business and IT services from the optimal set of internal and external providers” [1]. Recent actual deal announcements in the offshore outsourcing space seem to corroborate the trend [5]. The value of IT service multisourcing in the offshoring arena is explored by [3], who argue that multivendor deals and frequent updating of multivendor strategies are particularly beneficial to the outsourcing firm when global vendor markets change rapidly. In the manufacturing domain, the concept of “multiple sourcing” or “multivendor sourcing” refers to a business model where a firm utilizes multiple suppliers as opposed to a sole supplier for a particular component [11] [14]. Multivendor sourcing is in contrast with single sourcing, where the client develops tightly-integrated relationship with a single supplier for a particular component [15]. “Parallel sourcing” - a practice often found among leading Japanese automakers - refers to using multiple suppliers with comparable capabilities who are simultaneously sole-source suppliers for similar components [11] [16]. Unfortunately, the manufacturing literature adds somewhat to the confusion among terms as parallel sourcing is actually also a type of multivendor strategy with a particular duration and nature of supplier relationship. On the firm level, a manufacturing firm may end up with thousands of suppliers [10]. These suppliers form a complex, interconnected supply network [17]. Within this network, the sourcing client is termed “focal firm”, while the set of suppliers that are actively managed by the client through contracts and purchases is termed “supply base” [18]. 2.2.

Outsourcing Outcome

From the IS literature we identify four key measurements of the benefit of IT service outsourcing: cost reduction, flexibility increase, access to valuable resources, and service improvement, e.g.,

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[19] [20] [21]. The last three - flexibility, resource, and service quality - are also termed “noncontractibles” [22]. The literature also highlights two types of risk: structural risk and operational risk [23]. These outsourcing outcomes are consistent with those in manufacturing supply base management, e.g., [18]. This section reviews each of these benefits and risks in both IT service and manufacturing. The purpose of synthesizing findings from these two domains is to identify the commonality between IT services and manufacturing outsourcing. 2.2.1. Cost The most important driver of outsourcing for many firms is cost reduction. A firm’s total cost in sourcing is the sum of production cost and transactions cost [24]. Production cost in outsourcing mainly refers to the price for acquiring services of a given contractible quality without including transaction costs. Thus, such price includes vendors’ actual production cost and vendors’ profit. On occasion, these costs also involve the client’s own production costs that may be involved in outsourcing, such as rework costs [25]. Transaction cost is a term that has been used to broadly describe all sorts of costs associated with transacting with an external service provider, including costs incurred in searching, creating, negotiating, monitoring and enforcing contracts as well as the costs for coordinating activities with and among suppliers [26]. It should be noted that in the literature, there are mixed views on which of these costs belong to the label of transaction cost. Some consider coordination cost as part of transaction cost, e.g., [24], while [27]’s original definition treats coordination and transaction costs separately. To avoid confusion surrounding “transaction cost”, we avoid this term and view the total cost of outsourcing as consisting of three types: contracting, production and coordination costs. Transaction cost can also refer to risks of opportunistic behavior of the vendor that goes beyond contracting cost. We will deal with this and other risks separately, not trying to convert every risk into a cost.

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2.2.2. +oncontractible Besides cost reduction, other major benefits of outsourcing include flexibility increase, access to suppliers’ valuable resources, and service improvement, e.g., [21]. These outcomes are also termed “noncontractibles” [22], because they involve suppliers’ investments that are more difficult or even impossible to specify contractually. Flexibility in IT outsourcing manifests itself in a firm’s ability to successfully evolve its IT systems as markets, technologies, and supplier capabilities change [28]. It can be conceptualized along four dimensions: robustness, modifiability, new capability, and ease of exit [29]. In supply base management, flexibility is also reflected in a firm’s ability to respond to time-sensitive requests in a timely fashion [18]. A firm’s flexibility in sourcing is part of the firm’s overall “operating flexibility”, that is, the ability to arbitrage in the real and financial markets by shifting production factors and resources among different units of the firm [30]. Access to suppliers’ valuable resources is widely seen as a key strategic benefit of outsourcing, e.g., [31] [21]. The scope of valuable resources is very broad and may encompass the professional talent of suppliers’ employees as well as suppliers’ organization-level technical, business, and industry expertise. In particular, acquiring advanced technological skills has been reported as one of the top reasons for IS outsourcing [32]. In some cases, suppliers’ deep business and technical know-how can also help client firms strategically transform their operations and organizations [33], or generate innovation for the client firms [34] [35]. Service quality delivered by suppliers is an important factor of outsourcing success [36]; [37]. Broadly speaking, service quality refers to the difference between the service customer’s expectations and perceptions [38]. Service quality can be conceptualized along five dimensions: reliability, responsiveness, assurance, empathy and tangibles [38]. Specifically, reliability refers

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to dependable and accurate delivery of promised service; responsiveness refers to the willingness to help customers and provide prompt service; assurance refers to the knowledge and courtesy of supplier employees and their ability to build trust and confidence; empathy refers to caring, individualized attention provided to the customer; tangibles refer to related physical facilities and equipment and the appearance of service personnel [38]. While some aspects of service quality can be contracted, for example, through Service Level Agreements, in this paper we consider non-contractible aspects of service quality. 2.2.3. Risk Sourcing-related risk generally refers to the potential occurrence of an incident where suppliers do not meet client demand [18]. Risk in sourcing can be broadly categorized into structural risk and operational risk [23]. Structural risk is caused by vendors’ deliberate, opportunistic profitseeking behavior which reduces clients’ financial benefits; operational risk is caused by unintentional breakdown in executing tasks [23]. It is worth noting that risk can also be seen as a type of cost. In particular, structural, or strategic risk is very close to the definition of “opportunism cost” [23] [24]. However, in this paper we have only included actual costs incurred to the client in the contracting process in the definition of costs, and we view the costs associated with vendors’ opportunistic behavior as a risk as they may or may not take place. Structural risk, according to the definition of [23], refers to the risk caused by the misalignment between incentives of the client and the vendor. In IT service outsourcing, structural risk may take several forms. The first form arises when vendors under-invest in the relationship with the client by reducing employee training, management attention, etc. The second form is vendors’ potential dramatic escalation in pricing during contract renewal; this is often due to vendors’ rising negotiation power as a result of clients’ transferring of process and

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knowledge to the vendors. Other forms of structural risk include vendors’ acquisition of clients’ proprietary processes and technologies and eventually becoming a competitor, e.g., [23] [18]. Operational risk is associated with the unplanned and unanticipated occurrence of events that negatively affect the flow of goods or services in a supply chain, e.g., [39] [40]. Operational risk generally encompasses, among others, disruption and delay of delivery, information system breakdown, inaccurate forecast, expensive and inflexible supply capacity, low service quality and high error rates [23] [40]. In IT service outsourcing, the limited codifiability of outsourced work and therefore the requirements for tacit knowledge, and the lack of metrics to measure service quality are two important causes of operational risk [23]. 3.

THEORETICAL FRAMEWORK

This section synthesizes the concepts related to multisourcing in both IT service and manufacturing and identifies the impact of two characteristics of multisourcing supply base on different aspects of outsourcing outcome. 3.1.

Characterizing Multisourcing Supply Base

We adopt the term “supply base” from the OM literature and apply it to IT service to refer to the set of contractual supplier relationships that are directly managed by the sourcing firm at a given time. This definition is somewhat similar to the term “outsourcing portfolio” introduced by [41] in the IS literature, which describes the set of outsourcing contracts in force at a given time. 3.1.1. Supply Relationship Breadth According to the OM literature, two key characteristics of a firm’s supply base are considered most critical to the competitiveness of the firm. The first and most straightforward characteristic is the number of suppliers the focal firm uses for a given product or service, e.g., [42]. Drawing on the OM literature, we define the breadth of a firm’s multisourcing supply base as the number

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of suppliers the focal firm uses for a given business function. It is worth noting that we do not consider in this definition the case where different suppliers are used for different functions as such suppliers may or may not pose competition with each other. 3.1.2. Supply Base Depth The second characteristic of a supply base is the level of partnership between the client and the vendors, e.g., [12]. A close client-supplier relationship is often seen as key to success in manufacturing sourcing, e.g., [11] [12] [43]. This is a separate dimension as focal firms can often build quite significant commitment with their suppliers without agreeing to single-sourcing relationships. In fact, [11] points out that Japanese automakers often develop long-term relationships with multiple similar suppliers. Sometimes, one can obtain significant commitment from suppliers even in “extreme” multisourcing scenarios where many suppliers are willing to invest in the client relationship in order to acquire valuable skills or knowledge in a competitive situation [3] [44] [45]. In this paper, we define the depth of a firm’s relationship with a supplier as the focal firm’s level of investment in a particular supply relationship for a given function. Figure 1 illustrates these two concepts. Focal firm A has a high-breadth supply base, but each supply relationship has low depth. Focal firm B is the opposite. In reality, most supply bases are a combination of two archetypes, such as focal firm C.

Focal firm

High breadth, Low depth

Low breadth, High depth

Mixed type

A

B

C

Supply base Relationship-specific investment

Fig. 1. Supply base characteristics

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3.2.

Supply Base Characteristics’ Impact on Outsourcing Outcome

We review and analyze the impact of the breadth and depth of multisourcing supply base on the focal firms’ outsourcing outcome. The result of the analysis is a conceptual model (Figure 2). In the process of synthesizing the IS and OM literatures, we have identified a number of mediating variables in the relationship between the breadth and depth of the supply base and various outsourcing outcomes. In fact, rarely do the parameters of the supply base have a direct impact on outsourcing outcomes. Instead, we have identified four critical factors that have direct influence on outsourcing outcomes. These factors are: first, access to supplier’s generic capabilities such as supplier’s know-how, technical talent, and reusable technologies; second, supplier’s ability to utilize economies of scale within an engagement such as building a customized information system to streamline client’s order processing; third, client’s switching costs such as the cost of breaking a contract, transferring physical assets, knowledge transfer, etc.; fourth, each supplier’s client-specific capabilities which include the supplier employees’ knowledge of the client’s systems and processes and the ability to fine tune supplier’s offering to fit the client’s needs. In the following we elaborate on each relationship in this model. 3.2.1. Impact of Supply Base Breadth A major argument for the focal firm to increase the number of IT service vendors for a given function is the potential to select and utilize vendors with best-of-breed capabilities [3] [8]. Such capabilities are “generic” in the sense that they are accumulated across the vendor’s past projects with multiple clients, rather than specific to a particular client. Vendors’ generic service capabilities consist of a set of complementary capabilities, including technical competency, managerial skills and client facing ability that were built over time through the vendors’ exposure to a variety and multitude of clients [46] [47]. Strong vendor capabilities can result in

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vendors’ cost advantage that may eventually translate into the client’s cost savings through proper contracting [46]. Additionally, a vendor’s strong client-facing capabilities, such as methodologies for knowledge transfer, experience with client relationship governance, and interpersonal skills of vendors’ staff, can directly lower the client’s coordination cost, e.g., [48]. Increasing the breadth of supply base, on the other hand, has its downside from a production cost perspective. First, as the supply base broadens, the average amount of work sourced to each vendor is reduced. The consequence of the reduced size of each client-vendor relationship is limited economies of scale within the relationship, e.g., [49]. Specifically, the vendor’s upfront investment in the client, especially in training human resources and acquiring client-specific knowledge, is now spread across a smaller scale of ongoing work. Therefore, for a given unit of service delivered by the vendor, the average production cost is increased. Second, increasing the number of vendors raises administrative cost such as invoicing, order generation, etc. [49]. The cost of coordinating activities of multiple vendors is also increased [50]. Third, having a broad supply base involves a higher total cost of searching for, negotiating and contracting with the suppliers. Due to the opposite effects of supply base breadth on production cost and coordination cost as a result of increased access to suppliers’ generic capability but reduced economies of scale within the outsourcing engagement, supply base breadth has no definitive impact on the overall outsourcing cost, except increasing the contracting cost. Proposition 1.1. The breadth of supply base is positively related to contracting cost. Increasing the breadth of supply base may also bring non-contractible benefits to the client in the form of flexibility, access to valuable technical resources, and service quality. In terms of flexibility, on one hand, a broad supply base gives the focal firm access to best of breed

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capabilities, which potentially enable the vendors to better accommodate client’s requirement changes or bring new competency; on the other hand, misaligned incentives of different vendors and increased coordination cost potentially harm flexibility. A recent empirical study shows that increasing the number of suppliers alone cannot significantly increase outsourcing flexibility [51]. In terms of resources, increasing the number of suppliers gives the focal firm a broad set of “probes” [52] into potential pools of best of breed skills and talent. The broadened access to high-quality resources can improve firms’ innovation performance, e.g., [53]. Empirical studies of multivendor sourcing suggest that increasing the number of vendors can indeed bring the opportunity to tap into emerging supply markets, access skilled work force and gain first-mover advantage [3] [44]. Access to best of breed vendors as a result of increasing the breadth of supply base also improves the quality of service received by the clients. For example, vendors with strong competency in managing cultural differences with the client bring a higher quality of service [54]. Proposition 1.2. The breadth of supply base is positively related to the focal firm’s access to suppliers’ valuable resources, and received service quality, and the relationship is mediated by the access to suppliers’ generic capabilities Increasing the breadth of supply base can reduce the client’s dependence on each individual vendor and therefore lowers the possibility of being taken “economic hostage” [27] by the vendor. For example, in case a vendor under-invests in the relationship or opportunistically increases price, the client has the option to transfer the service to other vendors in the supply base. In other words, a broad supply base lowers structural risk. This benefit, however, is premised on the assumption that the client can switch from one vendor to another [22] [23]. Low switching cost includes two aspects. First, contractually, the client has the flexibility to terminate

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a relationship. Second, operationally, the client is able to transfer outsourced service from one vendor to another at a reasonable cost. In fact, if the vendors are quite different in their capabilities or the relationships are structured so as to prevent switching, the breadth of supply base may not lower structural risk. Similarly, operational risk can be mitigated by the presence of multiple vendors. In the event that one vendor fails to deliver, the focal firm has the option to transfer the business to other vendors [23]. The lower the switching cost, the less time and effort it takes to make the transfer and recover the supply chain. In summary, switching cost between vendors mediates the negative relationships between supply base breadth and structural and operational risks. Additionally, access to best-of-breed vendors, as a result of using a broad supply base, may also reduce operational risk, due to individual suppliers’ superior service delivery capabilities. In fact, superior supplier capabilities such as large vendors’ ability to switch locations and engage other backup systems may be a stronger way of reducing operational risk than switching between vendors, e.g., [55]. Proposition 1.3. The breadth of supply base is negatively related to the focal firm’s structural risk and operational risk, and the relationship is mediated by client’s switching costs. 3.2.2. Impact of Supply Base Depth Increasing the depth of supply base means that suppliers and the client have long term outlook on their relationships and are less interested in getting short-term gains at the expense of the other party. Prior literature [11] discusses this as a way of avoiding typical incentive misalignment. Thus, both parties may be willing to make long-term investments in the relationship. Such investments may enable the suppliers to develop capabilities that are specific to the client, i.e., “client-specific capability” [47]. Such capabilities may be tangible in their nature, e.g., a

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dedicated high-speed communication line, or intangible, such as knowledge of the client’s technological systems. Client-specific capabilities often result from suppliers’ deep understanding of the client’s business practices, routines and culture. The suppliers’ clientspecific expertise and continuous learning enable themselves to improve production and ultimately help clients to reduce production cost [12]. Also, a deep understanding of the client facilitates smooth communication and collaboration with the client and therefore lowers the coordination cost between the client and the suppliers, e.g., [47]. Proposition 2.1. The depth of supply base is negatively related to production cost and coordination cost, and the relationship is mediated by suppliers’ client-specific capabilities. Increasing the depth of supply base improves suppliers’ understanding of the client’s business, which potentially improves suppliers’ timely response to changes in client needs. For example, [31] suggest that a deep, alliance-like relationship is beneficial for flexibility in IT outsourcing. [51]’s empirical study confirms the positive impact of client-supplier partnership on outsourcing flexibility. In manufacturing, suppliers’ investment in human and physical assets specific to the client is critical to supply chain responsiveness [56]. Therefore, a collaborative long-term supplier relationship is critical in manufacturing supply base management [12]. From a resource perspective, in IT outsourcing, a close supply relationship enables the focal firm to acquire resources that complement its own weakness [31]. In manufacturing, deep supplier relationship has become a competitive advantage for industry leaders such as Toyota and Honda [12], helping them to innovate across organizational boundaries by leveraging the valuable resources brought by their suppliers [11] [57]. Finally, increasing the depth of supply base helps create a trusting, committed, and mutually understanding dynamic between the focal firm and its suppliers. In IT outsourcing, such a high-quality partnership contributes to the success of

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outsourcing from a service user’s perspective [37]. In manufacturing, deep supplier relationships are also considered beneficial for the improvement of supplier service quality [42] [58]. Proposition 2.2. The depth of supply base is positively related to the focal firm’s flexibility, access to suppliers’ valuable resources, and received service quality, and the relationship is mediated by suppliers’ client-specific capabilities. Increasing the depth of supply base implies that the vendors accumulate client-specific capabilities that cannot be easily replicated by other vendors. Such client-specific capabilities may include deep knowledge about the client and customized solutions [51]. In the event that the client switches to a different vendor, such capabilities are lost and the replication of these capabilities takes significant time and effort. Also, the incumbent vendor is reluctant to share and transfer such capabilities. Therefore, switching cost is increased due to high client-specific capabilities. High switching cost, on one hand, creates a dependent relationship that gives the suppliers the opportunity to lock the client in; on the other, it impedes transfer of business when supply disruptions occur. Therefore, both structural risk and operational risk increase. This is consistent with the finding that high level of customization lowers client’s ability to switch vendors or take their operations back in-house [51] [55]. Client-specific capabilities, as a result of increased depth of supply base, on the other hand, have a negative impact on the operational risk in outsourcing. This is mainly because the vendors’ increased client-specific capabilities improve their ability to respond to the client’s changing business requirements [12] [47]. Due to the opposite effects of supply base depth on operational risk as a result of increased switching cost but strengthened suppliers’ client-specific capabilities, supply base depth has no definitive impact on operational risk.

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Proposition 2.3. The depth of supply base is positively related to the focal firm’s structural risk, and the relationship is mediated by client’s switching costs. Figure 2 summarizes the above theoretical analysis. The oval-shaped components represent the mechanisms or mediating factors by which supply base characteristics impact outsourcing outcomes.

Costs

+

Contracting cost

+

Access to suppliers’ generic capabilities

Multisourcing Strategy

–

Economies of scale within engagement

Breadth

– – – + – – –

Production cost

Coordination cost

of supply base

Risks

– Depth of supply relationship

+

Switching costs

+ + – –

+

Structural risk

Operational risk

Suppliers’ clientspecific capabilities Noncontractibles

+

Flexibility

+ +

Valuable resources

+ +

Quality

Fig. 2. Theoretical framework 4.

CO$FIGURI$G MULTISOURCI$G SUPPLY BASE

According to their breadth and depth, we can broadly classify multisourcing supply bases into four “configurations”: high breadth, high depth; high breadth, low depth; low breadth, high depth; low breadth, low depth. We respectively term these four types diversified partnerships, diversified transactions, concentrated partnerships and concentrated transactions. Using the above theoretical framework, we discuss each configuration’s strengths and weaknesses and the type of outsourced work that is suitable for each configuration. 16

4.1.

Diversified Partnerships

“Diversified partnerships” involves using a significant number of suppliers that make significant client-specific investment to form a portfolio of partner-like relationships. The main strength of this configuration is the access to a broad set of both generic and client-specific capabilities. The weakness is limited economies of scale within the outsourced task and therefore potential lack of cost advantage. Risk can be mitigated if switching costs are properly managed. Given its unique characteristics, this configuration is especially suitable for outsourcing functions for which economies of scale within the outsourced work is not critical, but access to both best-of-breed and client-specific capabilities is key. One example of such tasks is project-based, customized, knowledge-intensive service such as specialized software design and development, e.g., [3]. In this type of work, both suppliers’ inherent expertise and deep knowledge of the client’s specific business are important, while economies of scale is limited due to the idiosyncratic nature of each project. 4.2.

Diversified Transactions

“Diversified transactions” involves using a significant number of suppliers that do not make significant client-specific investment to form a portfolio of relationships that resemble market transactions. The main strength of this configuration is low structural and operational risks, as well as acquisition of best-of-breed generic capabilities. The weakness is also limited economies of scale within the outsourced task and the potential lack of cost advantage. Given its unique characteristics, this configuration is especially suitable for outsourcing functions for which economies of scale within the outsourced work is not critical, but access to best-of-breed generic capabilities is key. One such function is the outsourcing of copier and printer services where firms often combine multitude of best of breed solutions.

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4.3.

Concentrated Partnerships

“Concentrated partnerships” involves using a small number of suppliers that make significant client-specific investment to form a few partner-like relationships. The main strength of this configuration is economies of scale within the outsourced task and therefore potential cost advantage as well as noncontractible benefits associated with suppliers’ accumulation of clientspecific capabilities. The weakness is high structural risk. One example of tasks that fit this configuration well are complex, large-scale IT services that require significant customized innovation from suppliers, often executed through strategic alliances such as Campbell Soup’s strategic partnership with IBM [59]. In this type of work, suppliers not only need to achieve economies of scale to reduce cost, but also need to collaborate closely with the client to continuously improve its operation. 4.4.

Concentrated Transactions

“Concentrated transactions” involves using a small number of suppliers that do not make significant client-specific investment to form a few market-transaction-like relationships. The main strength of this configuration is its low contracting and coordination costs and low structural risks due to lack of specific investment on either side of the relationship. Given its unique characteristics, this configuration is especially suitable for outsourcing functions for which operational risk can be properly mitigated and for which the vendor market has multiple vendors with comparable capabilities that match the focal firm’s needs. One example of such tasks is acquiring bundles of information commodity such as online reports, e.g., [60]. In this task, obtaining competitive market prices is the key decision factor. Figure 3 illustrates the strengths, weaknesses, and examples of appropriate applications of the four configurations. In reality there are many configurations. These four are “extreme”

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archetypes of multisourcing supply bases. For a given business function, the focal firm may also change the configuration over time to achieve the optimal business outcome. Depth

Concentrated Partnerships Pros:

High

Cons:

Diversified Partnerships

Economies of scale; Client-specific capabilities Structural risk

Pros: Cons:

Example: IT strategic alliance

Example: IT application outsourcing

Concentrated Transactions Pros:

Low

Cons:

Best generic capabilities Client-specific capabilities Low economies of scale

Diversified Transactions

Low contracting cost Low coordination cost Low client-specific capability

Pros: Cons:

Best generic capabilities Low structural risk Low economies of scale

Example: Printing services

Example: Digital goods purchasing

Low

High

Breadth

Fig. 3. Four archetypes of multisourcing supply base 5.

CASE STUDY

The previous sections have developed a conceptual framework that can be applied to both IT services and manufacturing. In the following we use the framework to illustrate in real business settings how companies strategically configure their IT service supply base over time and analyze the rationale behind their decisions. We also use the cases to further develop the theoretical framework, highlighting patterns of IT service multisourcing strategy. 5.1.

Methods

The study seeks to explore the impact of different IT service supply base configurations, and understand how firms strategically configure their supply bases over time. Given that the study is exploratory in nature and the phenomenon is deeply embedded in organizational practices, a case study framework [61] was adopted. The case method has unique advantages “when the investigator has little control over events, and wants to focus on contemporary phenomena within

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some real-life contexts” [61]. The study was conducted at two global financial services companies. We are refrained from disclosing their names and other specific information because of confidentiality agreements. For the objective of this paper, our cases serve mostly an illustrative purpose. We provide very brief overview of the method. A more detailed description of the method can be found in [Reference Suppressed for Review]. From 2005 to 2008, 74 in-depth, semi-structured interviews with 69 people were conducted at the first bank (Global Bank A), including managers across different levels from the bank as well as its vendors. The interviews broadly explored the bank’s outsourcing strategies, practices, and outcomes. The information used in this paper is a subset of the overall data. In 2008, 3 in-depth, semi-structured interviews with a director who oversaw the offshoring and outsourcing activities at the second bank (Global Bank B) were conducted. These interviews were focused on multisourcing strategy and were intended to provide a comparison with Global Bank A. Each interview lasted between 40 minutes and 2 hours, with an average length of about 1.5 hours. Archival data, such as presentation slides and public information, were collected to supplement the interview data. 5.2.

Company Background

In the following we first overview the business backgrounds of these two companies and then summarize their outsourcing histories. 5.2.1. Global Bank A Global Bank A was a leader in the financial services industry and a Fortune 100 company, with 2008 revenue of above 50 billion USD and thousands of employees across the globe. Global Bank A has a long history of IT service outsourcing and offshoring, which can be generalized into four phases. Phase I started in the 1980s, when the bank already established outsourcing

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relationship with several onshore vendors. Then in 1989, the bank contracted with a few Indian vendors to provide technical support to the bank’s operations in Asian countries such as India and Singapore. Global Bank A’s outsourcing entered Phase II in 2001, when the CEO mandated aggressive cost-cutting in the face of the slowdown of the financial services industry after the dotcom crash. In response, the bank adopted an aggressive outsourcing and offshoring strategy that led to the creation of a large supply base across the globe, including North America, Western Europe, Eastern Europe, Russia, and India. A diverse portfolio of supply relationships, including both long-term, strategic relationships and short-term, experimental relationships, were formed in this stage. For some divisions of the firm, there were over 50 vendors on their preferred vendor list. In 2003 the bank entered Phase III, when it decided to consolidate its IT service supply base by creating a program management office to orchestrate supply relationships. As a result, the bank successfully reduced its preferred vendor base and established deep relationship with about a dozen vendors. 5.1.2. Global Bank B Global Bank B was also a leader of the financial services industry and a Fortune 100 company, with 2008 revenue of over 50 billion USD and thousands of employees across the globe. Global Bank B’s approach towards IT services is very different from Global Bank A. Global Bank B has been very cautious about transferring IT services to external organizations and to offshore locations. Its outsourcing journey can also be summarized into three phases. Before 2003, the bank had some outsourcing activities with some onshore vendors. The bank’s offshore outsourcing journey did not start systematically until 2003, when it began to work with two major Indian IT service vendors and another smaller Indian vendor that was later replaced by a global vendor. We define this stage Phase I. In 2007, Global Bank B entered Phase II, during

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which the bank deepened its supply relationships, giving more core processes to the vendors and strengthening its mutual commitment with vendors. Since 2008, Global Bank B decided to broaden its supply base and implement multisourcing strategy by increasing its preferred vendor base from 4 to about 25. At the time of the interview, the bank was undergoing this expansion, and was expecting to enter Phase III, what the bank termed multisourcing model, by end 2009. 5.3.

Case Analysis

By applying the previously developed conceptual framework to analyze these two cases, we identify several themes that further refine and enrich the framework. Specifically, we use the two dimensions, breadth and depth, to illustrate and analyze the evolution of the two banks’ IT service supply bases over time. Then we identify the patterns of the evolution of their supply bases and elaborate the rationale behind their decisions. 5.3.1. Multisourcing pendulum The two banks adopted very different outsourcing paths within one IS function, customized IS development and maintenance. Interestingly, they seem to have been changing their supply bases in opposite directions. However, we observed one interesting commonality in the cases, that is, their vendor strategy was constantly evolving and seems to have been switching between using more and fewer vendors over time. We call this continuous, dynamic change of supply base configurations the “multisourcing pendulum”. In the case of Global Bank A, Phase I was characterized by the creation of relationships with a number of vendors. At the time, the trend of outsourcing in the financial services industry was just starting, and many offshore vendors were still in their infancy. Therefore, many of these relationships were experimental in nature. Taking advantage of the significant cost arbitrage was the primary purpose. Investing in building the capabilities of the vendors was not the bank’s top

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priority. The type of outsourced task at the moment was mostly low-end IT services that were run independently across bank’s divisions and exhibited limited economies of scale even when sourced internally. The supply base can be categorized as diversified transactions. What pushed Global Bank A into Phase II, aggressive outsourcing, was the increasing need to utilize the growing capabilities of offshore suppliers under the strong pressure to reduce costs. In this phase, the breadth of the supply base kept expanding as the bank sought to tap into emerging best-of-breed capabilities in diverse offshore locations. At the same time, the bank’s relationships with many key vendors were strengthened. The depth of these relationships increased as the bank’s various divisions invested significantly in developing the capabilities of their vendors, who then were able to undertake higher-end, more complex projects and deliver significant value to the client. The supply base in this phase moved toward diversified partnerships. As the supply base kept expanding, the bank felt the elevated management overhead caused by the fragmented and distributed outsourcing decision making. Therefore, the bank entered Phase III, starting to consolidate its supply base. As a result, the relationships with a select set of “strategic” vendors were furthered deepened, while many other relationships were terminated. In 2008, the number of vendors on the strategic vendor list was about a dozen. The supply base in this phase moved toward concentrated partnerships. In the case of Global Bank B, due to its unique business practices and corporate culture, the outsourcing journey started much later than Global Bank A. Before it started systematically outsourcing IT development and management, the bank outsourced small-scale, ad-hoc, low-end tasks to some local vendors. As the bank felt the increasing need to take advantage of the already mature capabilities of offshore vendors to reduce cost, it entered Phase I and created a low-

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breadth supply base consisting of three major vendors. The outsourcing was based on what the bank termed “co-management model”. Specifically, the bank managed the project itself but utilized the vendors’ staff as resources for a set of non-core, relatively generic tasks. Cost reduction by exploiting the readily available vendor capabilities, rather than by helping develop the vendors’ capabilities, was the primary goal of this phase. The supply base in this phase can be categorized as concentrated transactions. In Phase II, the bank deepened the relationship with the three key vendors and started moving toward what the bank called “full outsourcing model.” For example, in 2007, the bank outsourced a major IT function to a leading vendor. There was a high level of mutual commitment and investment between the bank and its vendors. In this phase, the goal of outsourcing shifted toward further leveraging the capabilities of vendors, rather than purely taking cost arbitrage. In particular, the bank started giving the vendors more core processes and more customized tasks requiring the vendors to make client-specific investments. The supply base in this phase moved toward concentrated partnerships. In the meantime, the bank also started planning Phase III. In this phase, on one hand, the bank will further deepen its relationship with existing vendors, outsourcing more value-adding tasks; on the other, it will broaden the supply base by diversifying it to about 25 vendors and implement the “multisourcing model”. The objective of this phase is to capitalize on a growing global talent pool and mitigate risk, while maintaining cost advantage. Eventually, the supply base will move toward diversified partnerships. Figure 4 shows the “multisourcing pendulum” of the two banks. As we can see from the cases, firms dynamically reconfigure their IT service supply bases, moving between a more focused sourcing model and more diversified sourcing model. This is a learning process as firms

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experiment with different configurations to explore the optimal supply base. This process is further influenced by firms’ changing internal business conditions and external market environments. Figure 5 illustrates this continued, ongoing multisourcing pendulum, swinging between “single sourcing” and “extreme multisourcing”.

Breadth Diversified Transactions

Diversified Partnerships Partnering

High

Bank A

Bank A

Expanding

Consolidating

Bank A

Bank B

Bank B

Bank A

Co-managing Low

Diversifying Bank B

Bank B

Full outsourcing

Concentrated Transactions Low

Concentrated Partnerships Depth

High

Fig. 4. Evolution of Global Bank A and Global Bank B’s supply bases

Single Sourcing

Extreme Multisourcing

- Significant lock-in risk - Lacking best in class - High operational risk

- High management overhead - Limited economies of scale - Low vendor commitment

Fig. 5. Multisourcing pendulum: experimenting supply base breadth

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5.3.2. Deepening supply relationship As the firms’ objectives shifted over time, both banks underwent the multisourcing pendulum. However, interestingly, behind such a pendulum, both firms have been consistently deepening the relationships with suppliers that remained selected by them. In the case of Global Bank A, when moving from diversified transactions to diversified partnerships, the bank moved from purely taking cost arbitrage toward reaping the benefits brought about by its vendors’ increasingly sophisticated capability. Such capability resulted from, first, the maturation of offshore locations’ IT service industry as a whole, and second, the bank’s continuous investment in training and educating its vendors’ personnel. The investment led the vendors to build up capabilities in the form of knowledge, skills, and practices that were specific to the client. According to the interviews, such a deepened supply relationship paid back in the form of access to strong technical expertise, improved service quality, and further cost reduction. In the consolidation phase, the primary purpose was to reduce the overhead associated with coordinating a large number of suppliers. By encouraging and directing its program managers to outsource work to a dozen preferred suppliers, the bank in effect further deepened its supply relationships by concentrating investment on the suppliers that were considered strategic to the bank. It is worth noting that, although achieving economies of scale was a key factor in the bank’s decisions in this phase, the bank still maintained a significant supply base and allowed its program managers to invest in other vendors they chose to work with. The main reason was that in knowledge-intensive, customized software development, economies of scale is often limited, due to the uniqueness of each outsourced task. The success of these tasks often depends on the vendors’ continuous investment in acquiring knowledge and skills that are specific to the client.

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This continued deepening of supply relationships is reflected in the description of one of the bank’s offshore vendors. (At Global Bank A), there is willingness to experiment with new types of partnerships. . . . They have also shown us a significant commitment. They have shown us tremendous willingness to educate us about how a bank works . . . They have shown us willingness to come to India for a lot of stuff. . . .We have shown a lot of commitment to [Global Bank A] in terms of making investment in people and time. [Relationship Manager of an Indian Vendor] Similarly, in the case of Global Bank B, thus far the bank has been focusing on moving from concentrated transactions to concentrated partnerships. Specifically, the bank has been transitioning from directly utilizing and managing vendors’ staff as low-cost resources toward systematically guiding the vendors to build up capabilities based on the needs of the bank. In this process, the bank started transferring more value-adding tasks and core processes to the suppliers. A more open, trusting relationship began to emerge. As for the future transformation, that is, toward diversified partnerships, the bank intended to better align its outsourcing requirements with the growth strategies of a broader set of suppliers, so that the bank can build up deep, mutually committed relationships with different vendors, and obtain high-quality service. Therefore, despite a broadening supply base, deepening supply relationships was also a key objective of the bank. The evolution of Global Bank B’s supply relationships was described by the bank’s global offshoring and outsourcing director as follows. Over the years we have built up a trusted relationship with our partners, so that we are now willing to give more of our core processes, more of our core competencies, and even

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some intellectual property to our partners. [Global offshoring and outsourcing director of Global Bank B] As can be seen from the outsourcing history of both banks, even though different objectives were pursued in different stages, deepening supply relationships has been a key theme in their IT service outsourcing strategy. 5.3.3. Leveraging supply base breadth While the supply relationships have been continuously deepened, the breadth of the supply base was used as a strategic tool by the banks to achieve different objectives in different stages of their outsourcing journeys. In the case of Global Bank A, when it increased the supply base breadth in the expansion phase of its offshore outsourcing journey, the main purpose was taking advantage of the emerging capabilities of various offshore locations. At the beginning of this phase, offshore vendors often lacked sufficient business knowledge, process maturity, and technical skills [62]. Therefore, while investing in selected vendor relationships, the bank’s program managers acted entrepreneurially and tapped into more vendors with unique capabilities from different regions to gain more options. One such example was using a vendor from Russia, a location where there were highly skilled engineers but the overall offshore IT service industry was still in its infancy. This experiment turned out highly successful and resulted in a long-term relationship. The strategy of broadening the supply base was explained by the bead of the bank’s project management office (PMO). We let people make relationships with whomever they wanted; do small projects offshore so that people see that it works and then encourage them to do bigger projects. [PMO Head]

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The expansion resulted in a broad supply base. Some program managers had to deal with three or more vendors, some of which were inherited from others due to internal reorganization, rather than selected by the managers themselves. In the consolidation phase, the main purpose was to reduce the cost of coordinating a broad supply base and achieve a certain level of economies of scale, while relationships with key strategic vendors were further deepened. Today [mid 2006] still, more than 50% of projects are one off. Yet, I believe that 80% of the work (in terms of volume) goes to the seven strategic vendors. [PMO Member] In the case of Global Bank B, when the bank started moving toward the co-management outsourcing model, the offshore vendors were already relatively mature. In this phase, focusing its management resources on utilizing vendor staff’s skills in low-end tasks and achieving economies of scale to reduce the bank’s cost was the top priority. Therefore, a low-breadth supply base was adopted, as explained in the following quote. We had very established relations, very established process. … We could deploy roles very quickly; we could leverage the salary arbitrage. … (There was) a very reduced number of vendors…. In terms of making it easy, making it quick, making it with the right partner for certain time, it was the right thing to do. [Global offshoring and outsourcing director of Global Bank B] When the bank transitioned from the “co-management model” to the “full outsourcing model”, it built up deep relationships with several strategic vendors. However, as the supply relationship stabilized, structural risk began to emerge. In particular, the bank’s management felt that one major vendor was reducing its management commitment to the bank and started to under-invest in the relationship. In the interviewee’s words, the relationship was “going lower and not as enthusiastic as it was at the beginning”. By broadening its supply base and

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developing deep relationships with a larger number of vendors, the bank seeks to reduce switching cost and create competitive pressure for vendors. Going to the next step, I think we should really broaden this, really create competition again. This is something we have announced to our vendors. They know all that. They will still be in the game.... (But) all these other vendors are coming new to our market. [Global offshoring and outsourcing director of Global Bank B] In summary, the breadth of the supply base directly impacts the focal firm’s access to best-of-breed supplier capabilities, economies of scale, and switching costs. In practice, firms strategically and dynamically configure their supply base breadths to enable themselves to adapt to changing internal business priorities and external market conditions. 6.

CO$CLUSIO$S A$D DISCUSSIO$

Multisourcing is an emerging strategy in the IT service domain, while similar practices have been extensively studied in manufacturing. In this study, we first synthesize existing research in both IT service and manufacturing literature to theorize about the impact of supply base structure on IT service outsourcing outcome. Based on the theoretical framework, we then identify different configurations of IT multisourcing and their characteristics. Finally, we use qualitative case studies of the IT service outsourcing practices of two global financial services companies to illustrate and refine the theoretical framework. Specially, the case study shows that the firm experiences a “multisourcing pendulum”, swinging between a small number and a large number of suppliers; however, behind such a pendulum, the firm consistently deepens its relationships with suppliers, while strategically and dynamically reconfigures the breadth of its supply base to meet changing business objectives.

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Interestingly, the continuous deepening of supplier relationships in IT service multisourcing is similar to some best practices in manufacturing, in particular the strategy adopted by leading Japanese automakers such as Toyota, e.g., [12]. In both cases, the focal firm invests in developing close relationships with its suppliers, and seeks to continuously learn, improve, and create value together with the suppliers. This approach is potentially even more critical for IT service multisourcing, because of the highly customized nature of the outsourced work, which requires the supplier to accumulate significant client-specific capabilities. In summary, IT service can learn from the managerial practices related to “deep supplier relationship” in manufacturing. On the other hand, in IT service, the breadth of supply base for a given business function may vary broadly, and there is no dominant trend of reducing supply base as in manufacturing, e.g., [10]. The reason is that unlike in manufacturing, in highly customized, knowledge-intensive type of service, economies of scale is often limited, and is not the key decision factor of supply base breadth. Firms flexibly reconfigure their supply base breadth to adapt to changing business needs such as exploring new capabilities and reducing switch costs. In summary, the trend of “supply base reduction” in manufacturing is not fully applicable to customized IT application development and maintenance outsourcing, although it may be applicable in other areas of IS outsourcing. This work leads to several future research directions. First, the study has shown that “deep supply relationship” in manufacturing can be applied to IT service. The next step could be examining how the specifics of this strategy can be migrated to the IT service domain. Second, the theoretical propositions developed in the paper have only been illustrated and preliminary verified in the case analysis. Future study should empirically test these propositions. Third, the

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