IT outsourcing in Australia is just over a decade old, launched inspectacular fashion by the SouthAustralian “whole of government”outsourcing contract with EDS in 1995.In this time, over 220 organisationshave entered into some 350 IToutsourcing contracts with over 112 vendors, for contracts totalingover $21.2 billion. Coincidentally, this period of IT outsourcing parallels ourexperience of the Internet, theubiquitous network of informationresources that now underpins modernlife around the world. This publicationdraws insights from a five-yearresearch project, conducted by theauthor, on the links between thecorporate “social capital” of firms in the global IT services sector andfirm performance. A key finding fromthe research is that like the Internet,the power does not exist with anyindividual entity; rather it is in how an entity is positioned in terms ofrelationships with other entities and in its ability to influence its position in that network.

This report is structured into foursections. The first section identifieskey phenomena that are shapingtoday’s market places and thatprovided the impetus for researchingsocial capital effects on the global IT services market place.

The second section explores howthese phenomena are playing out inthe Australian IT services sector byproviding an analysis of the AustralianIT services market from a networkperspective, looking at how firms andtheir senior executives are becomingincreasingly interlinked. The thirdsection takes a step back to look atthe global IT market, reporting onempirical research conducted at theglobal IT services level. The finalsection provides specific outcomesfrom the research in the form ofguidance for IT firms and clients onhow to prosper in an increasinglynetworked IT market place.

A Decade of IT Outsourcingin Australia: A CorporateSocial Capital PerspectiveLaurence Lock Lee Partner & Co-Founder Optimice Pty Ltd

Intangible Assets, Social Capital and Theory of the Firm

The events leading up to the dotcomboom and subsequent bust held somecompelling lessons for those that hadlived through it. Firstly, we learnt thatincredible share market value could begenerated based on future value potential,more so than past performance. While thedotcom bust added a reality check to thisphenomenon, it is worthnoting that today, sharemarket valuations,especially in the IT sector, continue to grow on the back of so called “intangibles”,more so than pastfinancial performance. For shareholders, returns have substantiallyfocused on market value appreciation asincreasingly firms havechosen to invest theirprofits in their owngrowth, rather than to return dividends toshareholders. These intangibles include afirm’s reputation, relationships withcustomers and partners, its human capitaland other internal resources/capital. Forthe research conducted, a firm’sintangibles were examined through thelens of its corporate social capital, whichis defined as “the set of resources,tangible or virtual, that accrue to acorporate player through relationships, inattaining its goals.” Corporate socialcapital was taken to include a firm’srelationship networks, absorptivecapacity, human capital, internal capitaland financial soundness.

A second phenomenon is the blurring ofwhat now constitutes the “firm”. As firmsincreasingly enter into alliances and jointventures, what is considered “inside” thefirm versus “outside” the firm is becomingincreasingly contentious. Just 750 equityalliances and joint ventures were formedin the USA throughout the 1970s, and

now thousands are formed annually in the USA alone1. The networks that formfrom such alliances alone would indicatethat corporate social capital will play a key role in a firm’s success. A goodillustration of the blurring of firmboundaries was illustrated by John Taylor,the former deputy CIO for Dupont:

The early “theories of the firm” werebased on transaction cost economics,which proposed that tasks would beoutsourced to external providers whenthe cost of providing the service internally exceeded that available in themarket place. Subsequent resource-based theories of the firm havebroadened the outsourcing decision fromsimply a financial one to include resourcessuch as core competencies, knowledgeand now social capital. This is indicativeof the IT outsourcing market today, wheremany factors other than financialconsiderations play a part in theoutsourcing decision. In a highlynetworked market place, where the trendis now more toward multi-sourcing thansole-sourcing, it is now conceivable thathow well a vendor is networked in themarket place could be one of thoseconsiderations. This research thereforeexplored the maxim of “it’s not what youknow but who you know” to the ITservices market.

Figure 1 – The Changing Business Model at Dupont(source: John Taylor, Dupont)

1 Pekar, P., & Margulis, M. 2003. Equity alliances take centre stage: The emergence of a new corporate growthmodel. Ivey Business Journal (May/June): pp.1-9.

Social Network Analysis (SNA) is atechnique used primarily for the analysisof public welfare applications in the fieldof sociology. SNA has been used herefor analysing the relationship networks ofmarkets. SNA provides a visualrepresentation of who is connected towho. Measures can be calculated toidentify those preferentially placed in thenetwork. According to social networktheory, the most prominent roles arethose of the “centrally connected”, whocommand attention through being highlyconnected, and those of the “broker” or“bridge”, who bridge different clusters orcliques. Central connectors exertinfluence through their central role intheir cluster of alliance partners. Brokersor bridges are often the source ofinnovation, facilitated by their ability toview across often disparate clusters.Both the roles for central connector andbroker/bridge have negatives as well aspositives. Central connectors can be

locked in to their own clique, making ithard for them to innovate. Bridges andbrokers could lack the power to takeadvantage of their unique positioning inthe network. The following graphprovides a simple illustration of theseroles in a network map:

The software used to spatially lay out thenetwork maps attempt to minimize thelink lengths and therefore nodes withcommon connections tend to clustertogether. While not foolproof, visualinspection of the maps can providesome early insight into areas for closerinspection and analysis.

Social Network Analysis – A Short Tutorial

The past decade of IT outsourcing inAustralia has seen the industry evolvefrom a substantially sole-sourcing market

to one where the mature outsourcingclients are adopting multi-sourcingstrategies and therefore increasing the

connectedness in the marketplace. Thefollowing graphic traces the evolution ofthe IT outsourcing market in Australia.

The blue circles represent vendors andthe red squares represent clients.Linkages represent a contractualagreement between vendor and client orvendor and subcontractor. As can beseen from Figure 3, as the volume ofoutsourcing contracts increased over the

decade, so did the interdependenciesbetween vendors and clients. This has ledto the situation today where a majority ofvendors and clients are connected eitherdirectly or indirectly. The following map ofcurrent contracts shows the existence ofa two-tiered market, where the major

vendors and multi-sourcing clients arenow interconnected. However, in thecentre of the map is a disconnectedcluster of smaller second-tier outsourcingcontracts (there is a minimum cut-off of$1million for all contracts on these maps).

The Australian IT Services Market

Figure 2 – Social Network Analysis Basics

Figure 3 – A Decade of IT Outsourcing in Australia

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The size of the nodes is related to thenumber of contracts the node is involvedin. Therefore the larger blue nodes are the vendors with the most contracts. The size of the red squares reflects therelative use of multi-sourcing by the client firm. The thickness of theconnecting lines reflects the relative sizes of the contracts involved. In terms of contract value, the top five vendors are still responsible for 80% of the totalcontracted value as shown below in Figure 5 :

Figure 4 – Current IT Outsourcing Market (Current contracts over $1million)

Market share statistics are a popularmeans for assessing the relative success of competing firms. However, it does little to provide insight into theimportant business relationship aspectsthat may be driving success or failure. In a multi-sourcing environment, it isinsightful to be able to look for patternswhere client organisations are using thesame cluster of vendors. The networkmaps on the following page show firstlyhow vendors are related through havingcommon clients. The thickness of theconnecting lines show the relativenumber of clients shared. An associationcould indicate complementary servicesand an ability to work together for asingle client, which is important in amulti-sourcing environment. On the rightis a similar affiliation map, but this timeshows how outsourcing clients areconnected through the sharing ofcommon vendors. This might providesome insight into the buying patterns of clients in terms of common needs.Again the thickness of the linesrepresents the relative use of commonvendors. The affiliation maps shownhave been filtered to show only thestrongest affiliations.

Figure 5 – Market shares by value and number of contracts

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The network analysis above has relied ondata on specific outsourcing contracts2.However, relationships are formed at apersonal level. We all intuitively know thatit is the personal relationships thatultimately create great company or clientrelationships. The most influential peoplein forming company relationships are thesenior executives. Vendor CEOs have theability to form multiple relationships withtheir client companies. In contrast, client

CIOs can usually only build relationshipswith the small number of vendors theycontract with. However, private sectorclient firms are often interconnectedthrough common board memberships.For public sector clients, movement of theexecutive between different agenciesprovides that shared market intelligence.

By using network analysis of affiliations itis possible to infer personal relationshipsthrough the existence of contracts

between vendors and client firms andalso between client firms throughcommon board membership. Seniorexecutives also tend to have a publicemployment history which can be asource of inferred contacts. The followingmap has been developed through datamining the employment histories ofvendor CEOs and client CIOs, CEOs andcompany directors3.

Figure 6 – Affiliation maps for vendors and clients

2 ComputerWire contracts data base from Datamonitor (www.datamonitor.com)

3 Data on IT executives was sourced from OneSource (www.onesource.com)

Figure 7 – Affiliation Map, Vendor CEO, CIO, Directors

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3 Data on IT executives was sourced from OneSource (www.onesource.com)

With just a few exceptions, the vendorCEOs tended to be clustered in one area,indicating that their strongest affiliationswere with each other through sharingcommon clients, further demonstratingthe impact of multi-sourcing and co-operative competition. The vendorCEOs in the cluster also make up the bulkof the top 10 vendors by contract value.This shows that being able to work

effectively together for common clients is now becoming more important. Thereare however large territories of the mapoccupied by directors and CIOs whichhave little penetration from vendor CEOs, reinforcing a view that relationshipsat the board level are not impacting ITsourcing decisions. The implication is that either IT sourcing decisions are notimportant enough to warrant board

attention or vendors have not been ableto leverage the board level relationships oftheir clients.

In terms of the level of connectedness,the Australian IT market characteristicsappear consistent with the global market.The next section looks at the results ofthe research on the global IT market.

What can be seen from the previous mapis that the major Australian corporationsare relatively well connected via board ofdirector interlocks, meaning thatintelligence can be easily shared at themost senior levels. The client CIOs appearrelatively less connected, though thiscould be the lesser public profile andtherefore lower level of data available onthem. At this time the board interlocks do

not appear to be impacting onoutsourcing decisions as there appearsminimal commonality between boardinterlocks and outsourcing contracts.

To further illustrate the relative disconnectbetween board level relationships andoutsourcing relationships, a personalaffiliation map was built between vendorCEOs, CIOs and client board members.Links were built between the vendor CEO

and the firms they have existing contractswith. CIOs had links with their currentemployers. Both vendor CEOs and CIOscould have previous employer links aswell, but rated at a lesser strength. Clientboard members had links to eachcompany that they were a board memberof. The resulting affiliation map calculatesa link between individuals based oncommon company affiliation linkages.

Figure 8 – Personal affiliations, vendor CEOs, CIO, Directors

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Corporate Social Capital and the Global IT Services Market

Figure 9 – Sample Industry Map of the Global IT Services Market

Writing in the American Journal ofSociology in 1981, former HarvardProfessor Harrison White proposedmarkets as self-producing socialstructures, where producers and buyersformed separate networks of cliques,and whose respective behaviours couldbe predicted by social structures withinthe market place. Since this time,White’s proposition is being played out,particularly in the growing servicesmarkets, where differentiation betweenproviders is often ill-defined and oftentemporary. To analyse the socialstructure of firms in the global IT

Services market, social networkanalysis techniques were used tovisualize and then analyse theconnections between IT vendor firms inthe market place. Connections weredefined as either joint venture oralliance relationships and/or contractualrelationships between vendor firms.Connections were identified throughbusiness press reports. Also derivedfrom these reports were the humancapital, absorptive capacity (measuredas R&D activity) and internal capitalcomponents of corporate social capitalof the firm. Combined with this was a

financial soundness measure derivedfrom accounting data. Regressionanalysis techniques were then used toidentify the impact of corporate socialcapital and its components on totalshareholder return, ROI and market tobook valuation. The results of thisanalysis are provided in the final sectionof this report. In this section theconnectedness of the global IT servicesmarket is illustrated.

The following schematic shows anexample of the use of SNA to illustratethe IT services market structure:

The dark circles are the selectedsystems integration firms that weresurveyed in the literature. The size ofthe nodes is scaled according to thenumber of connections they have. Thelines represent identified alliancerelationships. The thickness of the linesrepresents a strength of relationshipbased on the number of documentsidentified mentioning the connection.What is evident from this map is thatthose firms in the centre of the mapappear to have an advantageousposition by having multiple relationshipswith the systems integrators, who oftenact as gatekeepers to the end clients.For example, one can see that IBM is a

centrally connected node where thesize of its node is dictated by the largenumber of connections IBM has. Thelarger white circle firms towards thecentre of the map usually haveconnections to one or more of thesurveyed firms. These vendors could beseen as being advantageouslyconnected because of the multiplepaths they have available to customers,via the systems integration firms. Thefirms on the outside of the map appearto have less powerful positions due tohaving more limited access to the endclients through the systems integrators.

Based on the analysis above a networkmeasure of centrality was developed for

each firm which calculated the degreeto which a firm is connected to otherhighly connected firms i.e. the morewell-connected firms that a firm wasallianced with, the better the centralityscore. The centrality score was thencombined with other elements ofcorporate social capital i.e. the humancapital, internal capital, absorptivecapacity and financial soundness fortesting against firm performance. Theseother elements of corporate socialcapital were seen to be attributes thatwould influence other firms beingattracted to joint venture or alliance witha firm.

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4 For a closer examination of Multi-sourcing networks see http://www.optimice.com.au/upload/LEFJournalDec05_Multi_sourcing.pdf

Research Results and Recommendations for Prospering in the Globally Networked IT Market

The global information technologysector is arguably one of the mostnetworked of industry sectors. Thedotcom bust was the first time theindustry had experienced a substantialrecession, signaling maturation from astart-up growth sector to a maturingindustry sector. Management practicesnow need to be adapted from asituation where growth was almostguaranteed, to one where growth andprosperity have to be earned in anincreasingly competitive and globalmarket place. The global IT servicesmarket has also been traditionallycharacterised by rapid growth in market valuations. First Microsoft and now Google can claim marketvaluations that exceed industrial stocks that have existed forgenerations. These valuations arealso many times the size of the bookvalues of these firms, making anunderstanding of what contributes to a growing market to book gap critical.At the less glamorous end, the sector is populated by many unprofitable firmswith languishing share prices. The needto understand the impact of intangibleslike corporate social capital is thereforesignificant for the global informationtechnology sector.

Looking firstly at the social structure ofthe IT market place from a buyer’sperspective, one can observe that a“best of breed” approach to multi-sourcing can be somewhat naïve. Asillustrated in Figure 4, the vendorcommunity is highly interconnectedthrough contractual arrangements, andeven more so if non-contractual vendoralliances are included. A more astuteapproach to multi-sourcing would be togive due consideration to the pre-existing relationships that vendors have,looking for clusters of “pre-allianced”vendors to suit your services needs,rather than potentially invitingcompeting vendors into your business,with the resulting requirement forincreased governance to then managethese relationships. Additionally, buyers

are able to learn from other buyers asto what mix of services vendors mightprovide in terms of complementaryservices. From the vendor’sperspective, understanding the socialstructure of the vendor side of themarket will enable them to best developtheir services and position their alliancerelationships to maximize theirattractiveness to the buying communityas illustrated in Figure 9. As the use of multi-sourcing as a strategy4

increases, the onus is on the vendors to self-organise themselves into clustersto make themselves most attractive tothe buying community.

Looking beyond the structural marketelements to the empirical researchresults around corporate social capital,it was found that corporate socialcapital does indeed have a positiveinfluence on firm performance.However, it was also found that thedifferent elements of corporate socialcapital have different effects dependingon a firm’s size, profitability and ITindustry sub-sector. Financialsoundness was by far the biggestpredictor of firm performance. However,the larger, more mature firms in thesector have seen their share pricesstagnate despite posting consistentROI. This research indicates that forthese firms, financial soundness doesnot necessarily correlate with improvedtotal shareholder return. Oneinterpretation of these results is thatthese firms may have reached aplateau, and the market can’t seewhere their next level of growth willcome. Perhaps these firms need toconsider a complete revamp of theircurrent alliance relationships, in order to present a more innovative image tothe market.

In terms of market centrality, theresearch indicates that software firmsand smaller start-up firms can benefitfrom building a larger number ofalliances and becoming more centrallyconnected in the market place.

However, the reverse is true for thelarger, more established firms in thenon-software sectors. These companies can be penalised for beingoverly-connected, potentially signallingthat they are locked into a suite ofalliances that would ultimately limit their capacity to innovate and grow.

For the smaller, potentially loss-makingfirms, the research indicates thatinvestment in human capital ispotentially the only investment strategy that could result inimprovements in profitability andshareholder return. Investments by such firms in R&D or internal capitaldevelopments are likely to depressshareholder value and therefore shouldbe minimised in favour of human capitalinvestments. For the larger, moreestablished firms, investment in humancapital is beneficial for both ROI andtotal shareholder return.

Another important contribution topractice related to the above is thatinvestments in areas like R&D andinternal capital are only beneficial tothose firms who have the financialcapacity to afford it. Firms that do not appear to have the financialresources to support the level ofinvestments they are making in R&Dand/or internal capital would bepenalised in the market, with lower total shareholder return and market to book value performance.

Overall, the research provides specificguidance on how firms can improvetheir performance through appropriateinvestments in corporate social capital.However, guidance in terms of totalshareholder return is guarded, as theresearch also identifies that there aremany factors outside the confines ofcorporate social capital that can impact total shareholder return. Most of these factors are still unknown and in fact could be attributable to randomnoise effects beyond the control of firm management.

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The author gratefully acknowledges the data sources made available from OneSource (www.onesource.com) and DataMonitor(www.datamonitor.com).

OneSource, a division of infoUSA (NASDAQ: IUSA), is focused on delivering unparalleled breadth and depth of company informationto business professionals whenever they need it. OneSource’s ability to integrate content of different types from different sources iswhat sets OneSource apart in the high-end business information market.

Datamonitor is the world’s leading provider of online data, analytic and forecasting platforms for key vertical sectors. They help5,000 of the world’s largest companies profit from better, more timely decisions.

Acknowledgements

Optimice’s objective is to help our clients optimise their internal and external business relationships. Optimice has extensive experience in researching, analysing and facilitating improved business relationships.

In particular, Optimice aims to assist its clients to successfully navigate their way through the growing complexity of alliancenetworks, multiple sourcing contracts, offshore relationships, organisational restructures and the like, as well as help their staff tobecome more astute networkers.

About Optimice Pty Ltd (www.optimice.com.au)

Laurence Lock Lee is a principal and co-founder of Optimice Pty Ltd. Prior to forming Optimice, Laurence had undertaken research, consulting and management roles with BHP Billiton and more recently, ComputerSciences Corporation (CSC), where he led the Knowledge Management consulting practice and was a researchmember of the Global Leading Edge Forum. He has helped pioneer the use of electronic collaboration data to generate industry relationship maps for analysis. He has carried this work into his PhD research at the University of Sydney on the links between a firm’s corporate social capital and performance. He has published over 40 papers, book chapters and articles and presented at international forums in the USA, Europe, Asia and Australia. Email: llocklee@optimice.com.au

About the Author

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