IT Outsourcing and vendor cost improvement strategies under asymmetric information

Abstract

In this article, we study the scenario under which two information technology (IT) vendor firms compete for the outsourcing requirements of a client firm. The vendors' cost structures are private information. In addition, the vendors can improve their unit costs through learning-by-doing and by making investments in process improvement, that is, induced learning. We study the impacts of vendor-based learning and process improvement in the asymmetric cost setting on the client firm's outsourcing strategy and the vendor firms' process improvement investments. Our analysis reveals that the client firm may adopt the single-sourcing strategy or a combination of dual and single-sourcing strategies depending on the learning efficiency of the vendor base. We also find that high heterogeneity in the vendor cost structure increases the first-period outsourcing requirements of the client firm. Our findings provide interesting managerial implications for the IT outsourcing industry.