Data Analysis

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Chapter Four

The term risk is used in a wide variety of settings, and may take different meanings. In finance, for instance, the notion of risk refers to the variability of returns on assets. In insurance, risk is sometimes defined as the probability of loss, as a condition in which there is a possibility of a deviation from a desired outcome, or as the chance of loss. As is the case with other information systems researchers, throughout this study, we adopted the notion of risk exposure, wherein the probability of occurrence of an undesirable outcome and the loss associated with it are taken into account. Formally, risk exposure is defined as

RE=P(UO)L(UO),

where RE is the risk exposure, P(UO) the probability of an undesirable outcome, and L(UO) the loss due to the undesirable outcome. (Aubert 2002, 321-350)

In certain settings such as insurance, it is feasible to estimate the probability of occurrence of undesirable outcomes on the basis of past performance characteristics of the object under study. In areas where probabilities are difficult, if not impossible, to assess with such an approach, risk assessment methods approximate the probability of undesirable outcomes by identifying and assessing factors that influence their occurrence.

In the domain of IT outsourcing, transaction costs theory has provided a reference point for identifying the main risk factors and for operationalizing them. The theory is more applicable for vertical integration of organizations. The emphasis is not on the individual but on the context of the relationship between organizations. The logic and conclusions of TCT rest on the assumption that efficiency is the dominant criterion for organizational success. TCT assumes that firms engage in governance mechanisms such as outsourcing on the basis of an economic rationale. Such an assumption is relevant to the case of IT outsourcing decisions, which specifically address the question of producing a service internally or having it rendered by an external supplier. (Athearn 1989, 9-23)

Risk factors associated with the transaction

Asset specificity

Asset specificity refers to investments in physical or human assets that are dedicated to a particular relationship and whose redeployment entails considerable switching costs. In each case, should the relationship be terminated prematurely, the investment would be foregone. Asset specificity makes the investor vulnerable to ex-post exploitation, hence the lock-in problem. The supplier may use its specific investments into a relationship as bargaining power over the client at the time of contract renewal, since other suppliers would have to make the same investment if they were to get the contract. Given that contractual parties will act strategically in a “calculated effort to mislead, distort, disguise, obfuscate or otherwise confuse”, opportunism is at the heart of transaction costs economics and, it includes “self-interest seeking with guile” (idem). Under these circumstances, once the existence of a relationship-specific investment is recognized, switching suppliers is no longer a credible threat, and transaction costs related to negotiating, monitoring, and enforcing the contract are incurred. (Smith 1994, 26-32)

Small number of suppliers

Small number of suppliers refers to the degree to which a client has reputable ...