Informational technology outsourcing has emerged in early 70s and has evolved from service bureaus providing services and facilities management through software development, support and integration to total solutions management based on Application Service Provision (ASP) and Software as a Service (SaaS). The ASP model became popular in the late 90's with the emergence of the first wave of Internet enabled applications. The result of the ASP model was that the cost and innovation benefits were very limited. The market trend-spotters agree: SaaS is the next big step in the logical evolution of software and IT outsourcing. A survey of US IT executives by McKinsey & Co. in 2006 found that only two new technologies were viewed as highly promising tools for obtaining real business benefits in one being SaaS (McKinsey, 2006).
In the U.S., International Data Corporation (IDC) projected that the 2009 market for software-as-a-service (SaaS), would grow 42% when compared to the 2008 market. In its study, IDC also projects that more than three-quarters of U.S. organizations will use at least one SaaS business application by year-end 2009, and that growth prospects are strong in other world regions as well (Mahowald, 2009). IDC projects a further boom growth of the IT outsourcing market in the next decades. Thus, IT outsourcing became an important service industry und must be researched, especially its last trends such as ASP and SaaS.
Success of IT outsourcing projects depends significantly on suitable governance of customer-supplier relationships (Goo, Huang et al., 2008). In the modern literature are discussed two governance mechanisms - contractual governance and relational governance. Goo and Nam (2007) suggest that contractual governance is based on the formal controls which mean the written contract, management-initiated mechanisms designed to guide behavior toward desired objectives, whereas relational governance is unwritten, worker-based mechanisms designed to influence inter-organizational behavior (Goo, Nam, 2007; Ferguson, Paulin, 2004).
Some studies consider the
relationship between the contractual and relational governance mechanisms as substitute (Macaulay, 1963; Gulati, 1995) the others as complement (Poppo and Zenger, 2002; Goo, 2007).
The aim of this paper is to realize if the evolution in IT outsourcing changes the approaches to the governance of the IT outsourcing in context of ASP and SaaS and especially to study which degree of relational and contractual governance mechanisms suits best for fulfillment of obligations from ASP and SaaS vendor-customer relationships in distinction from traditional IT outsourcing. The second aim is to study the relationship between these governance mechanisms - complementarity versus substitution.
For these purposes will be studied definitions, instruments and mechanisms of contractual and relational governance, found out advantages and disadvantages of both models, compared the models with each other, considered relationship between contractual and relational governance, drowned the conclusion about what model suits best to IT outsourcing management in the context of ASP and SaaS.
In this paper will be reviewed and discussed relevant recent scientific literature such as journal articles containing empirical studies, theories, reviews and interpretations, as well as statistics and other papers concerning governance mechanisms of the IT outsourcing.
Contractual and relational governance
Definitions, instruments and mechanisms
Ferguson and Paulin (2004) consider contractual governance synonymous with the terms of hard, explicit, formal, and written contracts. In this sense, contracts are detailed, binding legal agreements that specify the obligations and role of both parties. As such, contracts can be considered substitutes for the formal governance mechanisms of hierarchy or integration in business-to-business exchanges. They describe "the contractual governance construct as the degree to which the formal contract is currently implemented in established service exchanges "(Ferguson, 2004).
Consistent with the literature, the relational governance construct is defined as the strength of the social norms present in the exchange (Noordewier, John, and Nevin 1990; Paulin, Perrien, and Ferguson 1997).
Contractual-based governance provides clearly articulated contractual terms, remedies, and process of dispute resolution. Relational-based governance promotes trust, relational norms of flexibility, solidarity, bilateralism, and continuance (Lee and Cavusgil, 2006, Ferguson, 2004). Relational governance is an endogenous mechanism that can enhance exchange performance by embedding private and public information flows in a matrix of social ties rather than by resorting to contract or its enforcement by a third party, such as courts (Uzzi and Brian, 1999). The reference point in relational governance is the set of relational norms that develops over time (Macneil, 1978; Williamson, 1985; Ferguson, 2004). Businesspeople often ignore the technically correct legal implications of contracts, which are often modified, supplemented, or completely supplanted by the norms of the ongoing relationship (Macaulay, 1963; Ferguson, 2004). There is general agreement that norms describe appropriate behavioral guidelines that enforce social obligation in the exchange (Heide, 1994; Heide and John, 1992; Ferguson, 2004). Shared norms and values are the hallmark of relational exchange (Brown, Chekitan, Lee, 2000), and they essentially develop through a socialization process in which the parties understand and endorse each other's expectations. Norms represent important social and organizational mechanisms for controlling the exchange (Gundlach and Achrol, 1993; Ferguson, 2004).
Conceptually, the assessment of the implementation of both contractual and relational governance indicates where a given exchange fits on the transactional-relational continuum. Weak social norms or a reliance on a strict implementation of the formal contract reflect transactional governance, and strong norms or little reliance on the formal contract indicate relational governance. (Ferguson, 2004)
Contracts, franchise agreements, and hostage taking are formal governance mechanisms in the Transaction Costs Economics (TCE) model (Uzzi, 1999, Ferguson, 2004). Yu, Liao, and Lin (2006) define contracts and financial commitments as formal governance mechanisms. Cullen, Sedon, Willcock (2005) have presented model of contractual governance mechanism consist of outsourcing contract, price framework and SLA. Sun, Lin, and Sun (2000) argue that contract clauses such as service level agreements and penalty-reward-mechanisms are key success factors for establishing an IT governance mechanism that contributes to outsourcing success. Contract safeguards act to minimize costs arising from exchange hazards and help firms to build initial institutional trust. (Williamson, 1985).
Following the premise of TCE, as exchange hazards rise, contractual safeguards include provisions and administrative procedures aimed at dispute prevention and resolution and the distribution of costs and benefits under various future contingencies. The manager, therefore, crafts governance arrangements to match the exchange conditions that accompany various services. (Williamson, 1985). Because crafting a complex contract is costly, parties undertake such a cost only when the consequences of a contractual breach are considerable. (Poppo, 2002)
Formal contracts represent promises or obligations to perform particular actions in the future (Macneil, 1978). For example, complex contracts may detail roles and responsibilities to be performed, specify procedures for monitoring and penalties for noncompliance, and, most importantly, determine outcomes or outputs to be delivered. Ferguson (2004) resumed the contract construct has previously been operationalized in studies of exchange governance in terms of the existence of a detailed agreement (Cannon et al. 2000), its enforcement under conditions of violation (Antia, Frazier, 2001), and the stipulation of expected behaviors and roles in the exchange (Lusch, Brown, 1996).
An SLA is defined as a formal written agreement developed jointly between a service recipient and a service provider in the IT outsourcing context that specifies a product or service to be provided at a certain level of quality in order to meet business objectives. SLA helps to clarify responsibilities, strengthen communication, reduce conflict, and build trust (Goo, 2008).
The SLAs have the following characteristics and possess following instruments. Foundation characteristics related to common beliefs, standards, objectives between organizations (Koh, et al., 2004; Ring and Van de Ven, 1994; Choudhury and Sabherwal, 2003) determine following instruments as service level objectives, process ownership plan, and service level contents. Change Management Characteristics related to ground rules and procedures for future contingencies, which would lead to desired outcomes, determine the following instruments future demand management plan, anticipated change plan, innovation plan, and feedback plan. Governance Characteristics related to a clear statement of the measurements, conflict arbitration, penalty and rewards and communication channel and method determine communication plan, measurement charter, conflict arbitration plan, and enforcement plan. (Goo, Huang, et al., 2008).
As such, SLAs are an important tool for managing IT outsourcing relationships and ensuring optimum performance (Fitzgerald and Willcocks, 1994; Goo, 2008). However, the existence of SLAs by no means guarantees the success of outsourcing. SLAs, in particular the earlier ones, often contain clauses and metrics dealing with only the most rudimentary service elements while ignoring such important issues as governance and changes in relationships, resulting in uncertainty in anticipating desired outcomes (Fitzgerald, 1994). On the other hand, in striving to capture all potential benefits, companies sometimes structure SLAs so comprehensively that their complexity makes them virtually unmanageable (Karten, 2004, Goo, 2008). Indeed, prior research has shown that poor outcomes of IT outsourcing are often attributed to failure in clearly defining specific goals, aligning contracts with strategic objectives, and making contracts flexible enough to adjust to changes in the business or the technology (Ang and Beath, 1993; Anderson and Dekker, 2005; Goo, 2008).
Relational governance in contrast to contractual governance applies other governance mechanisms. The researchers emphasize the following governance mechanisms of relational governance such as trust, commitment, relational norms, and mutual dependence, common values. (Zaheer, Venkatraman, 1995; Cullen, Johnson, Sakano, 2000; Barney, Hansen, 1994)
Sociological theories argued that any relational exchange relies heavily on social components - most frequently trust and commitment. (Morgan and Hunt, 1994; Macneil, 1980; Zhang et al., 2003) Trust refers to the confidence that exchange partners have for each other's reliability and integrity (Zhang et al., 2003), whereas commitment refers to partners' desire to continue a valued relationship (Yaqub and Vetschera, 2009) Sociologists have also demonstrated the embedded role that trust and other forms of social relationships play in economic transactions (Granovetter, 1985).
Zaheer and Venkatraman (1995) defined relational governance as interfirm exchanges which include significant relationship-specific assets, combined with a high level of interorganizational trust, and trust as one party's confidence in another's goodwill. Trust is made up of two components: calculative trust, the rational component of trust, and benevolent trust, the emotional side of trust (Doney, Cannon, 1997; Yaqub, 2009) "Calculative trust is preceded by the calculative process: an organization calculates the costs and/or rewards of cheating (or not) in a particular transaction. When one partner can deliver in the manner that it has promised, demonstrates the ability to continue the exchange relationship, or seems capable of generating some benefit for another partner in the future, another partner may be more willing to continue to make exchanges and to stay in the relationship." (Yaqub, 2009)
By benevolent trust, we mean the belief that cooperation creates a situation of mutual goodwill, and that partners will not take unexpected (non-cooperative) actions against one another (Cullen, 2000; Yaqub, 2009). Thus, benevolent trust with regards to manufacturing firms refers to the belief of suppliers that manufacturers will consider the supplier's interests or welfare. The longer the duration of the relationship and its associated assistance giving routines, the greater and deeper is the consequent benevolent trust (Dyer and Chu, 2000; Yu, 2006).
Dwyer, Schurr, and Oh (1987); Morgan (1994) define commitment as a party's belief that an ongoing relationship with another is so important as to warrant maximum effort at maintaining it. Researches have found that commitment is important for the success of IT outsourcing (Grover, Cheon, Teng, 1996; Lee and Kim, 1999; Koh et al., 2004). Commitment can guide the use of contracts to align actions in outsourcing relationships as well as provide the self-enforcing range of a contractual relationship by coaching outsourcing partners to be proactive beyond what the contract suggests (Klein, 1996; Kern and Willcocks, 2002). Also, commitment encourages procedural coordination such as active communication, conflict resolution, and open exchange of relevant ideas and feelings among participating firms. Commitment generates willingness to make contractual adjustments in current services and the delivery of new services by the service provider when unforeseen circumstances justify modifications (Gundlach and Cadotte, 1994). In an environment fostered by commitment, contracts are modified over time, and, thus, ongoing learning by outsourcing partners can be sustained (Mayer, Argyres, 2004).
The set of relational norms that develops over the time is a reference point in relational governance (Macneil, 1978; Williamson, 1985; Ferguson, 2004). Businesspeople often ignore the technically correct legal implications of contracts, which are often modified, supplemented, or completely supplanted by the norms of the ongoing relationship (Macaulay, 1963). There is general agreement that norms describe appropriate behavioral guidelines that enforce social obligation in the exchange (Heide, 1992; Heide, 1994). Shared norms and values are the hallmark of relational exchange (Brown et al., 2000), and they essentially develop through a socialization process in which the parties understand and endorse each other's expectations. Norms represent important social and organizational mechanisms for controlling the exchange (Gundlach, Achrol, 1993; Ferguson, 2004).
TCE suggests that the greater their mutual dependence, the more likely people are to conduct their transactions inside the boundary of a firm. The degree of mutual dependence in turn is largely determined by the extent to which assets can be redeployed outside the relationship. (Williamson, 2002)
For the success of IT outsourcing projects is necessary presence and effective function of all mechanisms of relational governance (Yu, 2006). The most often reasons of partnerships fails are poor communication, lack of trust, poor up-front planning, lack of shared goals, poor relationship management, and unsatisfactory performance indicators (Tuten and Urban, 2001, Ferguson, 2004).
Advantages and disadvantages of contractual and relational governance mechanisms
Governance mechanisms have their advantages and disadvantages. The advantages of contractual mechanisms are the following. Contract protects its parties against possible opportunistic exploitation in transaction cost economics. By providing formal rules and procedures to govern the relationship, these contracts serve as deterrence against possible opportunistic exploitation since a violation of contracts may lead to adverse economic and legal consequences besides the loss of reputation. (Williamson, 1985, Dyer, 1997; Poppo, 2002). Contracts are considered quite efficient to reduce the costs and performance losses caused by exchange hazards like hold-up, moral hazards, and resource appropriation (Macneil, 1978; Heide, 1994).
Careful negotiation of contracts can build relationships, and as Cannon et al. (2000) pointed out, the negotiation process can help structure expectations and obligations, as well as serve as a foundation for, and complement to, social governance mechanisms. They also noted that the negotiation process helps the parties work through problems, such as the definition of domains, resource commitments, and division of functions. In the early stages of exchanges, the contract may set forth a mutually understood performance level and provide a broad framework that can be replaced over time by the development of social norms based on trust, reciprocity, and interactions (Achrol and Gundlach 1999; DiRomualdo and Gurbaxani, 1998; Ferguson, 2004).
Disadvantages of contractual governance are that contracts increase the bureaucratization in economic life (Lange, 1938), make relationships inflexible (Young and Wilkinson, 1989), signal mistrust and may frustrate the building of trust (Jap and Ganesan, 2000; Gulati and Nickerson, 2008). Contracting increase the costs to negotiate, monitor, and enforce the contracts (Yaqub, 2009).
Contracts may form a straightjacket that blocks the utilization of unforeseen opportunities that arise especially in innovation (Nooteboom, 1999). As indicated in TCE, complete contingent contracting is often impossible due to uncertainty. Contracts may also encourage rather than suppress opportunistic behavior with respect to actions that cannot be specified within a contract (Klein, 1996).
Relational governance is cheaper than contractual, more flexible and self-policing, i.e. requires limited monitoring, since it is driven by intrinsic rather than extrinsic motivation. () In contrast with relational contracting with incentives from self-interest it is less sensitive to contingencies. () Findings with interfirm service exchanges demonstrate the predominant association between relational governance and positive customer-based evaluations of performance. (Artz 1999; Noordewier et al. 1990, Ferguson, 2004). Other benefits of relational governance include the mitigation of opportunistic behavior (Achrol and Gundlach 1999; Joshi and Stump 1999) and a moderation of contract enforcement in conflict situations (Antia and Frazier 2001). Trust may reduce transaction costs and lessen the need to monitor or safeguard exchange hazards, formal contracts may, beneficially, be replaced by trust (Dyer, Singh, 1998).
Joint planning and joint problem solving that make relational governance more efficient than market governance (Dyer, 1998). Joint planning allows mutual expectations to be previously established and cooperative efforts to be specified at the outset. Through joint problem solving, a mutually satisfactory solution may be reached for every contingency and consequently add to relationship success (Claro, Hagelaar, Omta, 2002). Mutual trust fosters learning and knowledge transfer (Kale et al., 2000).
Morgan and Hunt (1994) find that trust leads to cooperative behavior and decreases uncertainty. In addition, trust positively relates to less functional conflict, less stagnation, and the desire to resolve disagreement thus may increase productivity and performance. (Lee, 2006)
But trust may be also an element of risk and vulnerabilities. It remains always risk of opportunistic behavior of partner. The major problem is that the balance of interests, to prevent one-sided dependence, is difficult to ensure and maintain. It is sensitive to shifts in competence and external conditions. It is particularly vulnerable to the emergence on the scene of a more attractive partner for one of the players, who will then be tempted to defect and leave others with a gap in performance and worthless specific assets.
Reputation works only if breach of agreements can be observed, and can be credibly communicated to potential future partners of the culprit. If the culprit can move out with unknown destination this may be impossible. Also, the culprit may claim that the accusation is unjust and that there are ulterior motives to harm him.
Relationship between contractual and relational governance - complementarity versus substitutional view
A number of researchers in the governance area have argued that relational governance mechanisms such as trust substitute the need for formal contracts (Macaulay 1963; Gulati 1995; Ring and Van de Ven 1994). This stream of literature considers this substitution as operating through one of two mechanisms. Either relational governance eliminates the need for formal contracts and vice versa (Gulati, 1995), or formal contracts directly hinder the formation of relational governance (Macaulay 1963). In the former view, the presence of relational governance obviates the need for formal contracts because if one party trusts the other, there is little need for contractually specifying the obligations and responsibilities of the two parties. Thus, it reduces transaction costs by replacing contracts with informal self-enforcing mechanisms such as trust and reputation (Gulati, 1995). Formal contracts may also actually undermine the formation of relational governance. For example, Macaulay (1963) argues that the use of an elaborate contract indicates a lack of trust turning a cooperative venture into an antagonistic horse trade. Contracts may also encourage rather than suppress opportunistic behavior with respect to actions that cannot be specified within a contract (Klein, 1996).
Despite these convincing arguments about relational governance and formal contracts acting as substitutes, the logic for considering these two governance devices as complements, rather than as substitutes, appears to be equally compelling. Researchers have noted that the combined power of formal contracts and relational governance may be much higher in terms of safeguarding assets and they can jointly deliver much higher exchange performance than either governance choice in isolation (Baker et al. 1994; Mayer, Argyres 2004; Poppo, 2002). Other researchers have highlighted the complementary nature of formal contracts and interfirm-social cooperation (Arrighetti, Bachmann, and Deakin 1997; Burchell, Wilkinson 1997; Poppo, 2002).
Well-specified contracts narrow the domain and severity of risk to which an exchange is exposed and thereby encourage cooperation and trust. In addition, well-crafted contracts promote longevity in exchanges by increasing the penalties that accompany severing an exchange relationship (Baker et al. 2002; Klein 1996). Further, the process of developing a comprehensive and complex contract itself requires parties to engage in joint problem solving. Both parties have to work as a team to develop and negotiate the various provisions that will be incorporated in the SLA, including difficult aspects of the contract such as acceptable service levels, penalties for noncompliance, and future contract changes. These joint efforts also lead to the development of social relationships between the two parties. It is to be noted that the complementary relationship between formal contracts and relational governance may also function in reverse. The continuity and cooperation encouraged by relational governance may generate contractual refinements, as lessons learned during contract execution may be incorporated with mutual consent in contract revisions. This may further support greater cooperation in future periods (Goo, 2007).
TCE and related perspectives in contracting hold that bounded rationality and uncertainty prevent parties from writing detailed and complete contracts that deal with all possible contingencies (Hart, 1988), and the use of social mechanisms can play a role to complement the adaptive limits of formal contracts (Poppo, 2002). Thus, incomplete contracting encourages the literature to view formal and relational contracts as complements for one another, particularly when we are dealing with IT outsourcing contracts, which are necessarily incomplete (Mayer and Argyres 2004).
Poppo (2002) empirically showed that formal contracts and relational governance function as complements. These authors found that managers employed greater levels of relational norms as their contracts became increasingly customized, and utilized a higher degree of contractual complexity as they developed greater levels of relational governance. Thus, while results of this study provided evidence that relational governance can be used concurrently with a formal contract to achieve high exchange performance. (Goo, 2007)
Goo and Nam (2007) extend Poppo and Zenger's finding that formal contracts and relational governance function as complements, and not as substitutes. "We open the black box of complementary relationship and examine whether and what formal contractual clauses in SLAs lead to relational governance. Our results show that change characteristics in the formal contract dampen trust and commitment rather than reinforcing them, suggesting careful use of these clauses in outsourcing contexts. Second, this study contributes to the IT outsourcing literature regarding the role that SLAs can play in fostering harmonious, cooperative relationships that have high levels of trust and commitment" (Goo, 2007).
Relational-based governance complements contractual based governance in several ways. First, many scholars have argued that transaction cost economics overstates the desirability of contractual safeguards in exchange hazards. However, such complex contracts are costly. Unless the consequences of a contractual breach are considerable, parties usually will not undertake such a cost. Nevertheless, relational-based governance which emphasizes trust and its underlying normative behaviors operate as a self-enforcing safeguard that is effective and less costly to contractual-based governance. Second, many unforeseeable changes and vast dimensions of the exchange cannot be contractually specified. As a result, when unforeseeable disturbances arise, contacts are unable to maintain the continuity of the interfirm relationship (Poppo, 2002). Relational-based governance becomes a necessary complement to the adaptive limits of contracts by fostering continuance and bilateralism when change and conflict arise (Macneil, 1978). Third, the continuity and cooperation encouraged by relational governance may generate contractual refinements and further support greater cooperation (Poppo, 2002).
Alternatively, contractual-based governance may support relational-based governance. By specifying contingencies, adaptive process, and controls, customized contracts are likely to mitigate opportunistic behavior and thereby support relational based governance (Poppo, 2002). "In addition, well crafted long term contracts promote longevity in exchanges by increasing the penalties that accompany severing an exchange relationship. The process of contracting may itself promote expectations of cooperation consistent with relational-based governance because creating complex contracts requires parties to mutually determine and commit to processes for dealing with unexpected changes" (Poppo, 2002).
It can be summarized, that contractual-based governance provides clearly articulated contractual terms, remedies, and process of dispute resolution. Relational-based governance promotes trust, relational norms of flexibility, solidarity, bilateralism, and continuance. The combination of these two governance mechanisms may enhance alliance performance. (Poppo, 2002; Lee, 2006)
Traditional IT outsourcing versus ASP and SaaS
Definitions
Chaudhury, Nam and Rao (1995) defined IT outsourcing as the contracting of various information systems functions such as managing of data centers, operations, hardware support, software maintenance, network, and even application development to outside service providers. Lacity and Willcocks (1998), Willcocks, Fitzgerald and Feeny (1995) suggested IT outsourcing occurs when third party vendors are responsible for managing the Information Technology components on behalf of their clients. IT outsourcing means handing over the management of some or all of an organization's information technology, systems (IS) and related services to a third party. Kern and Willcocks (2002) suggest IT outsourcing describes a process whereby an organization decides to contract out or sell the firm's IT assets, people and/or activities to a third party supplier, who in exchange provides and manages these assets and services for an agreed fee over an agreed time period. Outsourcing is the handover of an activity to an external supplier. It is an alternative to internal production (Aubert et al., 2003).
Smith and Kumar (2003) defined an ASP as a single point of contact for all the telecommunications, hardware, software, and consulting necessary to deploy, run, and maintain hosted applications remotely. ''Any third party organization whose main business is providing software-based services to customers over a wide area network in return for payment'' (Smith, Kumar, 2004) These services can include enterprise (CRM and ERP), horizontal (functionally focused), and vertical (industry-specific) applications (Seltsikas, Currie, 2002; Ma, 2004). Other services include activities such as application upgrades, technical support, virus protection, data security, consulting, integration and staff training (Lepeak, 2001; Ma, 2004). As a result, the types of ASPs are complex and no one definition fits all of them (Ma, 2004).
"Application service providers offer web-enabled software applications on a subscription basis revisiting the traditional service bureau model of outsourcing, promising additional business benefits of economies of scale, increased scope of business applications, and enterprise application integration" (Desai, Currie, 2003)
Kern et al. (2002) consider application service providing as a special form of IT outsourcing. In this case, applications and the associated IT infrastructure are outsourced to an external service provider as part of a license agreement. This usually involves external outsourcing. The external service provider makes standard software with a low level of customizing capability available to various customers (one-to-many approach) and operates this in a central data center. The provider takes care of the license, operation and maintenance of the software, and is responsible for user service. The users access the application via the internet. The application is licensed to the customer and is usually paid for on a per user and per month basis. There are already a large number of ASP solution providers in the market. These include both pure ASP providers who market their own software as an ASP solution, and sales partnerships with established software manufacturers such as Microsoft, Peoplesoft and Siebel. The customer profile of ASP providers essentially consists of small and medium-sized businesses for who own development and own operation of the application would not be commercially viable. (Braun, Winter, NN)
The authors describe SaaS model as a new and customer-friendly way of IT outsourcing, where the vendor will own both the software and the IT infrastructure required for the online service, and where both parties will benefit from simple and attractive revenue logic, which is no longer based on the application development investment. (Sääksjärvi, Lassila, Nordström, 2005)
Comparative analysis of traditional IT outsourcing, ASP and SaaS
Application service provision have unique characteristics that set it apart from traditional IT outsourcing (Jeong, Stylianou, 2010; Kern, 2002). Table 1 is developed based on researcher of Kern (2002), it presents the main differences between traditional IT outsourcing and ASP.
Sourcing
model
Traditional
IT outsourcing
Application
Service Provision
Primary customer base
Large customers;
With own IT department
Small-to-medium enterprises;
Without internal IT department
Primary supplier base
Large suppliers,
potential global span,
familiar IT "brands", outsourcing is small part of business
e.g. Accenture, CSC, EDS, IBM, SAIC
Entrepreneurial, smaller firms;
local/regional focus;
not well known firms;
outsourcing is key revenue resource
Market comprises an estimated 1200 ASPs, predominantly start-up ventures
Resource ownership
Customer may retain or transfer ownership of all or some hardware and /or software
Customer retain control over custom-developed software
Supplier are responsible for server hardware
Customers provide client-side hardware
Supplier owns application licenses
Resource management
Supplier
Varies
Customer- to-supplier relationship
One-to-one or one-to-some
One- to-many
Typical location of supplier stuff
Mixed (some supplier stuff on customer site, some stuff centralized at supplier site)
Supplier staff not on customer site
Contract types
Primarily individually negotiated detailed contracts;
definition of service level and penalties for each customer;
long terms (often 10 years);
strategic partnering
Generic ASP contract specifying rental costs and very minimal service guarantees;
first payment and monthly usage fee;
short terms (1-3 years)
Functions
provided
Application development;
information utilities and business processes;
IT infrastructure
Web-enabled application delivery
Application functions for specific industry
Extend of customization
Client-determined
High degree of customization available, especially for application development
Deliver standard software packages with minimal change
Client pay for customization
Table 1. Traditional IT Outsourcing versus ASP (Kern, 2002)
ASP business model provides a one-to-many relationship model, where standardized or customized applications are offered to multiple customers across different sites, while traditional outsourcing is more likely to be that the customer has a one-to-one relationship with the supplier and the application is often tailored to the needs of that customer (Kern, 2002). The customer data reside on the ASP platform in the ASP model whereas in the traditional IT outsourcing relationships, customer data reside on the customer's platform. The customer retains ownership of software applications in traditional outsourcing environments whereas software applications are rented/leased to the customer on a recurring fee basis in the ASP context. Applications provided by the ASP are accessed by customers using browser windows through public and private networks, quite often the Internet. Unlike traditional IT outsourcing contexts where providers may have employees stationed at customer locations, or who at least make regular visits to customer locations, the ASP model allows providers to service customers over greater distances using networks without maintaining any physical presence of their personnel at customer locations (Swinarski, Kishore, Rao, 2004).
Which mechanisms fit best with outsourcing engagements in the context of ASP and SaaS
Swinarski et al. (2004) argue the ASP model in distinction from traditional IT outsourcing is geared predominantly towards providing application services that are relatively straightforward and can be well defined under service levels that can be easily specified and measured. Consequently, ASP relationships tend to be quite contractually-based. ASPs generally offer their business applications as packaged solution services with little customization (Swinarski, 2004). Other ASP characteristics determine also emphasis of contractual governance mechanisms in ASP-customer relationships. These are the following characteristics: one-to-many model of ASP-customer relationships, no supplier's stuff at customer site, application service delivery over the Internet, shorter service life circle, uncertain future of relationship. These characteristics do not promote development of customer-supplier relationships.
Transaction cost economics has argued that increases in exchange hazards will lead to the greater use of contractual governance mechanisms (Williamson 1991). The objectives of all stakeholders are to eliminate or mitigate these risks. Kern et al. (2002) argued that ASP sourcing has many of the same risks as traditional IT outsourcing, but the pattern of likely risks differs. Most risks are greater with ASP, but some are the same or less. Kern et al. (2002) researched characteristics of risks in ASP-customer relationships and proposed some risk mitigation strategies. In the table 2 are present some of these risks which are higher in ASP context.
Risk
Risk mitigation strategies
Supplier going out of
business
Select supplier with sound financial position, stable customers, and stable strategic partners; understand if and how supplier earns a profit; require notification of premature termination of contract; require transfer clause to facilitate moving the activity back to the customer or to another supplier.
Incomplete contracting
Detail contracts by including costs, service levels, and penalties for non-performance.
Application
unavailability
Negotiate service level guarantees with penalties for nonperformance for supplier-caused failures. (Suppliers cannot be held accountable for Internet failures.)
Slow response time
Negotiate service level guarantees for response time variables within the supplier's control; restrict applications to thin client versions for Internet delivery.
Table 2. ASP risks and risks mitigation strategies Kern et al. (2002)
In most cases, Kern (2002) proposes to mitigate risks using contract and SLA. It demonstrates that contract in context of ASP becomes more important governance instrument as in traditional IT outsourcing.
However, the research of Swinarski et al. (2004) suggests that an important prerequisite for a client to reap these promised benefits is to have a high degree of ASPs' commitment in the relationship with the customers.
Thus both governance mechanisms - contractual and relational governances - play an important role in shaping relationships between application service providers and their customers. But in the context of ASP and SaaS the degree of contractual governance increases.
Conclusions
In this paper were researched mechanisms of contractual and relational governance in IT outsourcing. For these purposes were studied definitions, instruments and mechanisms of contractual and relational governance, found out advantages and disadvantages of both models, considered relationship between contractual and relational governance. It were studied new trends in the IT outsourcing such as ASP and SaaS and drowned the conclusion about what governance model suits best to IT outsourcing management in the context of ASP and SaaS.
