Contracting and timing for outsourcing of information system with uncertain requirements

This research examined the impacts of market conditions on the choice of contract and timing for information system outsourcing. Real options approach is applied to develop several analytical models to investigate the decision making for outsourcing information system. The results show that the information asymmetry, requirement uncertainty, cost structure and vendor’s competition have important impacts on the client’s cost reduction, value of outsourcing option and probability of outsourcing. With symmetric information, the cost reduction, value of outsourcing option and probability of outsourcing under cost-plus contract and fixed-price contract are indifferent. With asymmetric information, however, the two contracts will generate different cost reductions and values of outsourcing option. We identify market conditions under which a contract is superior to others and also characterize the market conditions under which the client can switch to outsourcing or postpone outsourcing.