Offshoring of Application Services in the Banking Industry – A Transaction Cost Analysis

Gaining economic benefits from substantially lower labor costs has been reported as a major reason for information systems (IS) offshoring. However, many offshoring projects have failed to achieve expected cost savings, indicating that labor cost savings are offset by additional costs that arise in offshoring projects in certain situations. While previous research on IS offshoring has mostly focused on management issues in offshoring, the focus of this paper is to improve our understanding why the realization of economic benefits varies substantially between offshored software projects. Based on a conceptual framework from transaction cost economics and empirical data from an in-depth case study involving six software development and maintenance projects that were offshored to software vendors in India by a major German financial services organization, two research questions are studied. First, what types of additional costs may arise in offshored software projects? Second, how and why do additional costs vary between projects, considering both task and offshore characteristics? The findings from our analysis indicate that offshoring can lead to increased effort on the client side, both in terms of production costs (requirements specification, knowledge transfer, conceptual development) and transaction costs (vendor coordination, and control). These additional costs are particularly high when the outsourced function is highly asset specific. Moreover, offshore country characteristics such as cultural differences, geographic distance as well as vendor characteristics such as the degree of personnel fluctuation and lack of absorptive capacity can lead to cost add-ons at the client side – in particular when a high degree of human asset specificity is involved in the offshored software projects.