Contract Design Choices in IT Outsourcing: New Lessons from Software Development Outsourcing Contracts

Abstract

We study contract design choices affecting the complexity of outsourcing contracts, defined by the number and stringency of contract provisions employed, using 262 software development outsourcing contracts from a large European bank. Unlike extant research, we study the complexity of specific contract functions – safeguarding, coordination, and contingency adaptation – in both fixed-price and time-and-material contracts. The drivers of complexity we examine include not only transactional attributes, but also the “learning to contract” effect of prior experiences and of reliance on standard contracts. Moreover, unlike past studies, we also consider the high ex-ante contracting costs faced in some IT contexts, on the premise that design choices seek to minimize the overall transaction costs due to ex-ante contract planning and drafting and to ex-post opportunism and inefficiencies. Our results offer novel insights about specific contract functions that are masked by aggregate contract complexity measures used in past studies, and about pricing-based differences that are masked in mixed contract samples. Additionally, our results about the impact of transactional attributes and of the “learning to contract” effect (due to prior interaction and use of standard contracts) confirm the presence of tradeoffs between ex-ante and ex-post transaction costs as well as explain conflicting findings of past studies.

Keywords: outsourcing contract, contract functions, safeguarding, coordination, contingency adaptation, software development outsourcing, transaction cost economics