eric t g wang terry barron abraham seidmann management science vol 43 no 12 december 1997 l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Eric T. G. Wang, Terry Barron, Abraham Seidmann Management Science / Vol. 43, No. 12, December 1997 PowerPoint Presentation
Download Presentation
Eric T. G. Wang, Terry Barron, Abraham Seidmann Management Science / Vol. 43, No. 12, December 1997

Loading in 2 Seconds...

play fullscreen
1 / 44

Eric T. G. Wang, Terry Barron, Abraham Seidmann Management Science / Vol. 43, No. 12, December 1997 - PowerPoint PPT Presentation


  • 299 Views
  • Uploaded on

Contracting Structures for Custom Software Development: The Impacts of Informational Rents and Uncertainty on Internal Development and Outsourcing Eric T. G. Wang, Terry Barron, Abraham Seidmann Management Science / Vol. 43, No. 12, December 1997 outline abstract the model

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Eric T. G. Wang, Terry Barron, Abraham Seidmann Management Science / Vol. 43, No. 12, December 1997' - Melvin


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
eric t g wang terry barron abraham seidmann management science vol 43 no 12 december 1997

Contracting Structures for Custom Software Development: The Impacts of Informational Rents and Uncertainty on Internal Development and Outsourcing

Eric T. G. Wang, Terry Barron, Abraham Seidmann

Management Science / Vol. 43, No. 12, December 1997

outline
outline
  • abstract
  • the model
  • internal bargaining
  • investment
abstract
abstract
  • custom software development projects
    • information asymmetries
      • user valuation and developer costs
      • relationship-specific investments
      • positive externalities for the user or the developer from the other party’s investment
slide4
market prices for software are not helpful in solving either the valuation or the cost problems
  • analyze the unique nature of the software development agreements that can be reached between the user and the developer
slide5
compare the value of using internal and external developers
  • understanding the factors relevant to the outsourcing decision
slide6
when internal and external developers have identical cost functions
  • internal development definitely yields the larger net value
slide7
the model is similar to the two-stage contracting
  • emphasis on software development bargaining outcomes under
    • informational asymmetries
    • relation-specific investments
    • investment externalities
slide9
events and timing

system’s value is affected by

α user investment

β developer investment

ω user private information

q feasible system specification

switch cost

relationship-specific investment

requirements analysis

focus on α and β are not contractible

slide10
at bargaining stage
  • user => value
  • developer => cost
  • assume ω and θ are not correlated
    • θ(ω) will not change after learning ω(θ)
  • assume that there is only one potential outsourcer
slide11
central management
    • internal develop
      • budget balancer
    • external develop
      • has all bargaining power
  • welfare weight
slide12
user’s investment will increase the system’s value at a diminishing rate
    • creates positive investment externalities and also increases the system’s value
  • developer’s investment will increase the system’s value at a diminishing rate
    • creates positive investment externalities and also decreases the system’s cost
internal bargaining
internal bargaining
  • α and β has been made
  • two-sided incomplete information
    • user (developer) knows realized ω(θ) but not realized θ(ω)
  • optimal truth-revelation machanism
  • central management
    • maximize V(q, ω) - C(q, θ)
    • expect not to incur a budget deficit
slide18
user’s expected payoff
  • developer’s expected payoff
slide19
central management’s problem is to set the software specifications, the user’s charges, and the developer’s payment
    • maximize the system’s net value
slide20
characterizes the set of incentive-compatible and individually rational mechanisms
slide21
compensate for the costs of investments so that the user and the developer are willing to participate at the beginning of the project
slide22
in order to induce the user and developer to reveal their private information
    • some premium over expected cost is paid to the developer
  • if the expected system net value is large enough to cover both the user’s and the developer’s informational rents
    • central management can expect not to incur a budget deficit
slide24
the central management can expect to at least balance the budget while at the same time inducing truth revelation and achieving bargaining efficiency
investment
investment
  • first consider the case where the specific investments create no externalities
    • Vβ=0 and Cα=0
  • the efficient investments are
slide27
theorem 2
  • Given the efficient mechanism in period 2 (development), the ex ante investments are also efficient regardless of whether the investments are contractible, provided that the investments create no externalities.
slide28
central management’s beliefs are set at
  • user can predict the resulting specification of the new system
  • user knows her own optimal reporting strategy perfectly, she can predict the exact specification as a function of θ
slide29
at the outset, central management displays a mechanism (or a contract)
  • instructs the user and the developer to make investments equal to α* and β*
slide30
result shows that under-investment will not arise when the investments generate no positive externalities
  • if the investments do generate positive externalities, under-investment occurs
external bargaining
external bargaining
  • user’s problem in period 2 for a realized ω can be formulated without loss of generality as
slide32
incentive compatible and individually rational payment

extra cost that the user has to pay the developer

slide33
optimal system specification for outsourcing

informational rent required for inducing truth-revelation

investment34
investment
  • user offer a contract based on
    • realized ω
    • investment α
    • beliefs developer’s investment
  • letting denote the user’s optimal system specification given
slide35
with the developer’s beliefs about user’s investment fixed at
  • developer’s optimal investment
  • first condition
slide36
given beliefs about the developer’s investment
  • user’s optimal investment
  • first condition
slide39
if the value and cost of developing the system are the same for internal and outsourcing
    • how the cost is evaluated
  • internal
    • no real resources have been transferred out
  • outsourcing
    • outsourcer’s profit margin
    • real dollars that the organization has to pay
numerical example
numerical example
  • k = 1, s = 2, t = 1, t0 = 1
slide42

Figure 3

Figure 5

slide43

Figure 4

Figure 6

managerial and research implication
managerial and research implication
  • an internal developer can be expected to have a substantial advantage over an outsourcer
  • rational firm will behave in just this way
    • 186 projects from 5 firms
      • 64% custom / insource
      • 17% custom / outsource
      • 11% package / insource
      • 8% package / outsourced