Week7_Susarla et al. (2010)_Aaron

Firms are increasingly relying on IT outsourcing to improve services quality and to lower in-house IT spending. However, practitioners and academics have seen high rates of failure in IT outsourcing due to holdup problems, which are represented as underinvestment and inefficient bargaining because of contract incompleteness. There is a tension on the understanding of holdup problems. One stream emphasizes the importance of clearly designed contract whereas the other believes that the nature of contract is incomplete.

Drawing on the argument from latter stream, Susarla et al.(2000) argue that contract extensiveness, defined as the extent to which firms and vendors can foresee contingencies when designing contracts for outsourced IT services, can alleviate holdup. Moreover, they argue while extensively detailed contracts are likely to include a greater breadth of activities outsourced to a vendor, task complexity makes it difficult to draft extensive contracts. Furthermore, extensive contracts may still be incomplete with respect to enforcement. They therefore examine the role of non-price contractual provisions, contract duration, and extendibility terms, which give firms an option to extend the contract to limit the likelihood of holdup. Using a unique data set over 100 IT outsourcing contracts, they test and support those arguments in their research model.

As to their contributions, first, they support the argument that contracts are fundamentally incomplete and suggest that non-price provisions play a strategic role in contracts design. Second, to extend the literature of contractual solutions to holdup problems, their findings suggest payoffs from repeated interactions between parties reduces the probability of inefficient bargaining. Last but not least, this study also complements prior analytical work by providing empirical evidence to understand how parties anticipate and design contingencies ex ante that are important to manage potential problems ex-post.