Using analytic hierarchy process to analyze the information technology outsourcing decision

Godwin G. Udo Tennessee State University, Nashville, Tennessee, USA

Keywords

Outsourcing, Analytical hierarchy process, Decision making, Management techniques, Information technology

Introduction

The rapid growth of information technology (IT) in industries today is a mixed bag of opportunities and problems. On one hand, IT presents many opportunities in that Abstract Due to the strategic importance of companies have used it to help them gain a IT, there exists an undeniable competitive edge. On the other hand, IT need for a systematic analysis presents problems in that the management of before deciding whether or not a IT is a major headache to several companies. particular IT function should be outsourced. A study that provides In effect, cost-effective deployment and usage a systematic analysis for of IT resources has become a strategic evaluating components of the company's IT for outsourcing may success factor for business firms (Neilson, be useful to practitioners. In this 1990). Firms, in a time of growing global paper, analytic hierarchy process competition and scarce economic resources, (AHP) is proposed as a suitable are striving to create efficient organizational technique for analyzing information systems outsourcing structures that include cost-effective (highly decision. An IT outsourcing case is productive) information system (IS) used to demonstrate the functions (Earl, 1996). Organizations are so usefulness of the proposed approach. Expert Choice is used overwhelmed by the complexity and need for to implement the AHP. In the case urgent attention demanded by IT example, managing IT by the IT department seems to be the best management that they are willing and ready option followed by managing it to try any technique. Some managers think through an outsourcer. Managing that since they do not have a good IT by the end users is the least understanding of the technology, there is no preferred technique in this hope in attempting to manage it. A common particular example. practice among companies therefore, is to look and ask around to see how other companies handle their IT challenges in order to imitate without asking many questions. For example, since Eastman Kodak successfully outsourced most of its information systems, several other companies have followed suit without a systematic analysis of the consequences of their actions. The recent trend among firms today is classifying their information technology functions into two categories: commodity and strategic services. They argue that the commodity services can be outsourced while Industrial Management &
Data Systems 100/9 [2000] 421429 # MCB University Press [ISSN 0263-5577] The current issue and full text archive of this journal is available at http://www.emerald-library.com

strategic services should be kept in house. IT function is defined as the total resources (measured by total costs) a firm commits to providing information for decision-making and IT-based services. However, Lacity and Hirschheim (1993) maintain that this type of classification can lead a firm into serious problems in the future. In the first place, the so-called commodity service may be very critical to the operations of the firm and as such, caution needs to be exercised in outsourcing such services. Second, a strategic service can rapidly become a commodity service in a matter of months. The implication here is that a more vigorous method needs be employed in deciding whether or not to outsource and what aspects of IT should be outsourced. A study that provides a systematic analysis for evaluating components of the company's IT for outsourcing may be useful to practitioners. Few managers know how to evaluate outsourcing as a management tool. Managers should not be allowed to guess or take chances regarding this important decision. In this paper, analytic hierarchy process (AHP) is proposed as a suitable technique for analyzing information systems outsourcing decision. AHP can be used to rank all possible alternatives of outsourcing using several criteria. It converts subjective assessments of relative importance into a linear set of weights that can be used in ranking the alternatives. With this technique, several options are considered in the decision analysis that make it possible for a company to adequately evaluate and determine whether particular IT should be outsourced. This approach may be helpful to the practitioners who are faced with outsourcing task. The paper presents a case of IT outsourcing decision analysis using AHP to demonstrate the effectiveness of the proposed approach.

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Information technology outsourcing

IT outsourcing has become a commonplace event in organizations across the USA. The cheap and highly skilled labor pool obtained abroad has led to a sudden increase in global outsourcing. Recently, Du Pont reached a ten-year deal with Computer Sciences Corp. and Andersen Consulting to outsource its IT at a cost of $4 billion (Computerworld, 1997, p. 67). On this deal, Du Pont has transferred about 3,000 of its IT employees to the outsourcing company while about 1,200 remain with the company. AT&T announced plans to cut or reassign 4,300 computer workers (57 per cent) because of its merger with NCR (Keller, 1991). In fact, several US corporations such as Citibank, Texas Instruments, New York Life Insurance, and Boeing, have successfully outsourced parts or all of their IT services to other countries, including India, Ireland, the Philippines, and Russia, to name just a few (Shereff, 1989). Global IT outsourcing is a lucrative alternative that provides capital market gains and cost savings, a larger pool of skilled vendors, and quicker development cycle time. However, its pitfalls include resistance from IT professionals, poor quality, lack of coordination, and poor communication between the firms and the vendors. As technology increasingly impacts the ability to compete in world markets, the streamlining of corporate organizational structures, with the goal of improved productivity of human resources, has become a major strategy for survival and growth (Earl, 1996; Saarinen and Vepsalainen, 1994). The strategic move of realigning the IT function within a firm is often a major component of wider corporate streamlining. Outsourcing of the IT functions can be viewed within the context of a firm's downsizing in which multiple functional areas are affected, or as a strategy in which only the functions are involved. It is apparent, then, that IT outsourcing, not being an end in itself, is a part of the broader context of the firm restructuring. Lacity and Hirschheim (1995) noted that although IT outsourcing started over 34 years ago, it has recently taken on a new scope. Initially, IT outsourcing was limited to such tasks as payroll, insurance processing, mailing list, etc., but now it involves multiple systems that may include the transfer of leases, personnel, and assets to the vendor. In a typical IT outsourcing, the vendor will charge a fixed amount for a set of services called ``baseline'' within a fixed number of years. Within the contract period, any

services not included in the baseline have to be purchased for an additional cost. The projected savings are often very attractive and supported by press reports. Unfortunately, failures of IT outsourcing are not adequately reported in the press since no company is particularly pleased to be identified with failure. IT outsourcing decision making has a strategic importance and so should be systematically analyzed. Outsourcing vendors often cite the following benefits of outsourcing (Thompson, 1991): . gaining a predictable technology budget by tying it to actual requirements, not the current hardware and software. This implies that users buy for only what they need; . cost savings compared to the current and anticipated future expenditures to purchase or lease new equipment; . greater access to technical resources and skilled technical staff; . company focuses on the core products and services and not operational issues; . variable rather than fixed costs for the technology, which in turn can free up capital to be invested in core business; . risk sharing with the technology partner in such high-cost, high-risk areas as application development. Many observers maintain that outsourcing has more disadvantages than advantages. The potential disadvantages include (Lacity and Hirschheim, 1993; Hoffman and Vijayan, 1997; Nam et al., 1998): . the ``chemistry'' may be lacking between the vendor and client; . the danger of depending on a third party for your critical information need can be scary; . it may lead to the loss of a capability that could potentially be a key success factor (hollowing); . it can lead to loss of control of IS/IT assets; . possible threat of opportunism from suppliers; . it can lead to loss of flexibility; . it may lead to the loss of competitive advantage in information management; . it can lead to the loss of IT expertise and corporate memory; . it can cause a decline in morale and performance of the remaining employees; . long-term cost savings are not guaranteed. IT outsourcing decision making has a strategic importance and so should be systematically analyzed. There are many and complex decision variables involved in this type of decision-making situation. Some of the major decision variables for IT outsourcing decision are the strategic

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importance of the services rendered, vendor factors, customer interests, and employee interests. Most of these variables are qualitative and so the effectiveness of many of the existing decision analysis tools can be questioned. AHP has been effectively applied by several researchers to decision-making problems (Expert Choice, 1998; Tarimcilar and Khaksari, 1991; Yau and Davis, 1993; Saaty, 1990, 1994) whose structures are similar to that of IT outsourcing. The following section deals with how AHP can be used in making IT outsourcing decisions.

Analytic hierarchy process

The AHP is a mathematically based, multiobjective decision-making tool which was introduced by Saaty (1990). It uses the pairwise comparison method to rank order alternatives of a problem that are formulated and solved in hierarchical structure. The technique has the advantage of being simple and thorough in handling difficult real-life problems. It provides greater utility in applications where information is either incomplete or not available. The AHP approach has been adopted in many applications including resource allocation (Barbarosoglu and Pinhas, 1995), business performance evaluation (Lee et al., 1995), project selection (Mustafa and Al-Bahar, 1991), and auditing (Yau and Davis, 1993). Additional application areas include problems in public policy, marketing, procurement, health care, corporate planning, transportation planning and many other areas (Saaty, 1994). The AHP requires a problem be decomposed into levels, each of which is comprised of elements or factors. The elements of a given level are mutually independent, but comparable to the elements of the same level. The structure presupposes that elements of any given level are influenced by elements at the level immediately above them. The process of AHP comprises the following steps: 1 Structure a problem with a model that shows the problem's key elements and their relationships. 2 Elicit judgments that reflect knowledge, feelings, or emotions. 3 Represent those judgments with meaningful numbers. 4 Use these numbers to calculate the priorities of the elements of the hierarchy. 5 Synthesize these results to determine an overall outcome. 6 Analyze sensitivity to changes in judgment.

A major strength of the AHP is the pairwise comparison where the influence of elements of a particular level over those of a lower level is measured. Since two elements of the same level can be compared at any given time to a particular element at a higher level, this simplifies the process to a large extent. Comparisons are provided by means of experienced judgments or from data and experiments (Saaty, 1990). When N elements of a given level are being compared, a total of N( N-1)/2 comparisons are needed. The second half of the comparison matrix is the reciprocals of those judgments lying above the diagonals and usually omitted. Judgments are provided by means of a ninepoint ratio scale that ranges from two factors being equally important to one of the factors being absolutely more important than the other. After the expert supplies the ratings, local priorities of each element are calculated by approximating the principal eigenvectors via the geometric mean method. At the end of the analysis, global priorities are obtained by synthesizing each of the local priorities. Transitivity of preference is determined by the consistency ratio and implies that if X is preferred to Y, and Y is preferred to Z, then X is preferred to Z. A consistency ratio of 0.10 or less implies a more consistent judgment that is acceptable.

Application of AHP to IT outsourcing decision analysis

For this example, let us assume that an IT outsourcing decision is based on five groups of criteria categories as shown in Figure 1. This grouping is not exhaustive but serves as a demonstration of this proposal. Other variables can be added to the model based on the particular needs of a given company. The three options included in this case example are: outsourcer; IT department; and end user; with occasional use of contracts on shortterm basis. A brief explanation of the criteria is given below. Top management of the company who have expertise on these areas are to be used in evaluating and ranking the criteria which are in turn used to evaluate a given IT function for outsourcing decision. This group of decision variables deals with the question of deciding the effect of the IT services on achieving the strategic goals of the firm. The general concept is that the IT that provides strategic services should not be outsourced but those that provide nonstrategic services could. Firms pay great attention to their strategic IT because in

Strategic importance

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Figure 1 Hierarchy model of outsourcing case

extreme cases, such IT could as well be the difference between success and failure for the firm. It would be a serious mistake for a firm to outsource its strategic IT because once the system is duplicated, it fails to play a strategic role. The specific strategic importance variables are grouped into four categories and discussed as follows.

ineffectiveness can be corrected with a minor reorganization or policy changes. Outsourcing should only become an option when all remedial programs fail. This decision variable is considered the most important because firms and outsourcing vendors often cite internal ineffectiveness as the main reason for outsourcing. The second criterion deals with the impact of the decision on the stakeholders of the company. It also entails how the stakeholders will perceive the transaction. It is not enough that the shareholders' interest is protected; they also have to be convinced. The stakeholders include the employees, the customers, and the suppliers. Their interests are discussed below. This class of decision variables deals with the possible effects of IT outsourcing on the customers and the suppliers. These effects could be real or imagined but their opinion and perception must be taken into account before outsourcing decisions are made. Specifically, the following questions should be asked in order to determine the customer's interest: 1 Does outsourcing add value to the customers and suppliers? Or do customers and suppliers perceive this decision as adding value to them? 2 Can the firm be perceived by the customers and suppliers as being stable or will this decision create a notion of bad sense and instability? 3 Will the firm's relationship with the customers and suppliers be positively or negatively affected? 4 What long-term effects will the decision have on the customers and the firm's

1 Opportunities to distinguish the firm

If IT can enhance a firm's ability to distinguish itself, the firm's strategic position in the industry can be greatly enhanced therefore the IT can be said to provide strategic services. If the services provided by a particular IT are critical to the core operations of a firm, they could be said to be of strategic importance. It would not be in the best interest of a company to depend on an outside company to provide the IT services that are so critical to its core business. The idea here is that firms should only outsource those IT services that support non-critical operations of the firm. Firms should first decide whether or not the expertise of the laid-off knowledge workers will ever be needed in the future. If the industry is still undergoing some growths, chances are the information needs of the firm may change in the future and so today's nonstrategic IT can become a strategic hot cake tomorrow. Outsourcing IT services may imply that the firm no longer involves itself with its IT staff development and hence it is stripping itself of the knowledge workers that may be crucial in the future. Firms should not outsource their IT services on grounds of internal ineffectiveness without first providing corrective or remedial programs. The IT department

Stakeholders' interest

2 Critical service

Customer and supplier interests

3 Being stripped of knowledge

4 Internal expertise ineffectiveness

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ability to gain new customers or suppliers? 5 Will the customers and suppliers accept the vendor or will the decision create conflict of interests among them? A careful consideration of these factors will help a firm decide whether or not to outsource its IT services. This set of decision variables concerns the effect of outsourcing on not only the IT staff but also other workers in the firm. Outsourcing could lead to low morale and negative attitudes among employees, which in turn could lead to productivity problems. Firms also have a moral obligation to account for employees' interest when making a decision on IT outsourcing. The factors to evaluate include: . Continued employment. The firm should endeavor to retrain and employ the replaced IT workers. The firm can also make it mandatory that the vendor continues to employee the IT staff. If no continued employment is provided for, IT outsourcing may not be an attractive option. . Union issues. Where a union exists, a firm should first explore its legal possibilities before deciding to outsource. Agreement could be reached with the union if outsourcing can be justified to be beneficial to all parties. The existence of union should automatically imply that outsourcing can not be considered. . Morale problems. Firms should analyze the possible morale problems that could result from the decision and so make plans to handle and resolve such problems. If the cost of morale problems is higher than the benefit of outsourcing, the firm should not pursue the option for the sake of productivity and good will. . Replacements. If employees are difficult to deal with and if it becomes impossible to strike a deal with the workers, the firm should analyze replacement possibilities. If replacement is more expensive or not possible, IT outsourcing should be discouraged. This group of decision variables deals with issues related to the type of vendor to whom the firm should entrust its IT services. If there are no vendors that rank favorable on these issues, then IT services should not be outsourced. The vendor issues to be considered include competency, availability, dependability, cost efficiency, and an effective in-house expertise to enforce the

outsourcing contracts. If there are no competent, dependable vendors that are geographically and otherwise close to the firm, IT outsourcing may not be a good alternative. In addition, there has to be a competent in-house workforce dedicated to enforcing the contract. The big question that must be answered is which of the decisions is the most cost effective. Cost seems to be the main reason companies want to undertake IT outsourcing. The common complaint against IT department is the cost compared with the level of service satisfaction. The vendor or outsourcer has to be much more cost effective than the IT department before outsourcing can be considered a viable option. The cost of operation as quoted by the outsourcer has to be compared to the cost of end-user computing and IT department budget. The outsourcer must be asked to reveal all the costs including possible increase in the subsequent years.

Employees' interest

Cost of operations

Industry environment

The nature of the industry should be considered when deciding for or against IT outsourcing. If there is much competition in the industry, or if the industry is in its infancy/growth stage, IT outsourcing decision should be made very cautiously and carefully. Depending solely on an outsourcer for IT services may not be a wise decision in such an environment. A stable and mature environment may be more suitable to IT outsourcing since most of the uncertainties of IT usage have been fairly contained or predicted. Age of company, trends in the industry, degree of competition, and responsiveness to change are some of the variables in this group of criteria. Decision making with AHP helps the decision maker to prioritize alternatives so that the best one can be selected. The priority values can also be used as evaluation or performance measures (Expert Choice, 1998). Businesses, government and even other organizations seek to perform and be able to evaluate their actions with measures of performance. The managers are asked to report on how well their divisions are doing and how well the performance compares with the performance of the previous periods. AHP with Expert Choice can combine not only dollar value or probabilities of events, but intangibles like customer satisfaction and non-dollar variables like response time, into an overall performance measure.

Software implementation of AHP

Vendor issues

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Fernandez (1996) has given an overview of Expert Choice. Expert Choice is a multiattribute decision support software tool based on the AHP methodology. This tool can help the decision makers to examine and resolve problems involving multiple evaluation criteria. The software uses the AHP methodology to model a decision problem and evaluate the desirability of alternatives. The active research on many aspects of this technique aside, AHP has become increasingly popular among practitioners for its comprehensible and insightful analysis of complex problems. The academic and practitioner literature cites several research and application papers involving AHP. Expert Choice software requires a minimum of 8Mb of RAM and 10Mb of disk space. The Expert Choice software assists the user in all phases of the problem-solving process, from model formulation to final report output. The structuring module feature assists users in creating an AHP model of the decision problem. The Evaluation and Choice module is the principal component of Expert Choice and is used for creating a model, eliciting expert comparison assessments, solving a model, performing sensitivity analysis, and generating reports. Expert Choice decision models follow the standard AHP format, a functional hierarchy with the broad overall goal or objective at the highest level. Lower levels correspond to the criteria and respective sub-criteria used to choose among alternatives. Figure 1 illustrates an AHP model that can be used for analyzing IT outsourcing decision. The goal is to decide whether or not a particular IT function should be outsourced, handled by IT department, or allow the end users to provide the function in their respective units. The five criteria under the goal represent the principal considerations for making IT outsourcing decision. Note that this particular hierarchy is not symmetrical since any criterion can further be divided into the sub-criteria. The three alternatives are at the lowest level of the hierarchy. Very large AHP models can be created using Expert Choice, since the software allows up to nine children nodes for each parent node. Even larger models can be accommodated by a technique of clustering and linking between nodes. Very large models can impose significant effort in eliciting pairwise comparison assessments. In such cases, Expert Choice provides a

Numerical example

rating capability in which alternatives are not compared against each other but are compared against standards or norms. Expert Choice provides two methods of developing a decision model: direct construction using the Evaluation and Choice module, and assisted construction using the Structuring module. The Structuring module provides an interface mechanism for deriving criteria and subcriteria. It is a framework for collecting ideas and transforming these into an AHP model, a facilitating mechanism for constructing models. The Evaluation and Choice module provides the facilities for model creation, pairwise comparisons, solution synthesis, sensitivity analysis and report generation. The next step after constructing the model is to perform comparison assessments leading to the AHP solution synthesis. In the case example, five experts were asked to evaluate the three possible options of IT management (outsourcer, IT department, or end user with contracts) based on the five criteria by comparing the criteria with each other with respect to the goal. Expert Choice Pro provides excellent facilities for performing these comparisons. The expert opinion was elicited with questionnaires, which were produced from Expert Choice. The numerical questionnaire for the first level of a decision model for selecting an IT management technique is shown in Figure 2. Inconsistent expert judgment can be a factor when using the pairwise comparison method. The Evaluation and Choice module calculates and displays the inconsistency ratio (IR) of the AHP technique. The IR of 0.04 was obtained in this example. The IR provides a measure of the logical rationality of the pairwise comparisons: a value less than 0.10 is generally considered acceptable. The pairwise comparison mode can be extended from 1-99 in the numerical mode and in the graphical mode. After the decision model was completely developed and expert judgments made for all alternatives, the Evaluation and Choice module was used to synthesize a solution to the model. The final result is an overall weight for each alternative. The results are presented in bar graph form (Figure 3). As shown on Figure 3, IT department has a weight of 0.347, outsourcer 0.334 and end user with contracts 0.319. This interpretation of this solution is that IT department is the most attractive option for this particular IT function based on the expert opinions about the five criteria. The solution also reflects the combined importance that the human experts give to each of the five criteria. In this case example,

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strategic importance scored 0.300, stakeholders' interest 0.180, cost of operations 0.220, vendor issues 0.160 and industry environment 0.140.

Sensitivity analysis
Sensitivity analysis examines the sensitivity of the results to changes in the priorities of the criteria. This is a particularly important aspect of an AHP problem analysis, since results are based on subjective expert assessments. Sensitivity analysis can be performed from any level in the hierarchy; the software displays the sensitivity of alternatives to priority changes of the criteria immediately below a user-selected node. This flexibility is very useful for fine tuning the sensitivity analysis. The Evaluation and Choice module provides five

different graphical modes for performing sensitivity analysis: 1 performance; 2 dynamic; 3 gradient; 4 two-dimensional plot; and 5 differences. Each of these graphical modes provides a different viewpoint to a sensitivity analysis. Under any of these five modes, the user can easily manipulate criterion priorities and immediately see the impact of the change (as reflected in the ranking of alternatives). Figure 4 shows the graphical interface of the performance sensitivity analysis of the IT case. In this case example, the sensitivity analysis was performed with respect to the goal node, which is selection of IT management approach. A decision maker can easily use the mouse to change any of the weights of the criteria and observe the corresponding changes in the weights of the alternatives and their graphical display. This feature makes it possible and easy to perform several ``what-if'' analyses once the model is created and tested.

Figure 2 Comparison of relative importance with respect to the goal

Conclusion
Analytical hierarchical process has been proposed as a potential tool for analyzing information technology outsourcing decision. The advantage is that AHP has the ability to handle complex, multicriteria, qualitative decision variables involved in the IT outsourcing decision-making process. The proposed approach is expected to improve the quality of IT outsourcing decision making. It is expected to provide the practitioners with a systematic analysis needed to make this important decision. The case example given in this paper proves that AHP can be used effectively to analyze IT outsourcing decision. It provides a computerbased group decision environment needed to capture experts' opinions on several criteria in order to decide whether or not to outsource an IT function. The sensitivity analysis of AHP is particularly helpful in that it provides real-time, interactive, graphical display of the ranking of the options as the decision makers compare different scenarios and possibilities. This study proves that it is possible to use a systematic approach to analyze information system outsourcing decision and by so doing reduce the high level of uncertainty prevalent in this type of decision making. With this approach, the decision-making process can be consistently repeated and documented while sensitivity analysis can be

Figure 3 Solution of the outsourcing case

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Figure 4 Performance sensitivity analysis

performed on the best option before any action is taken. The example of the case study does not include all possible decision variables and so cannot be used in a real-life case without modifications. However, the results of the case study are of interest to both practitioners and researchers. In the case example, managing IT by the IT department seems to be the best option followed by managing it through an outsourcer. Managing IT by the end users is the least preferred technique in this particular example. The management implication of this finding is that organizations should first exhaust all options within their IT department before deciding to outsource their information systems. The results indicate that the IT department can do as well and even better than outsourcers. In the advent of end-user computing development, many believe that organizations can function well with very small or no IT department. The results of this study indicate that without the support from IT department, end users cannot yield the computing excellence needed for today's competition. We believe that a well-planned coordination and interaction between the IT department and end users can provide a much more efficient management of IT than most organizations think to be possible.

References and further reading

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Godwin G. Udo Using analytic hierarchy process to analyze the information technology outsourcing decision Industrial Management & Data Systems 100/9 [2000] 421429

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