(A) study on performances of incentive mechanisms in the IS outsourcing : computational modeling and simulation

Abstract

Recently, Information System (IS) outsourcing has been recognized as one of the important factors to succeed in business. Now, it is not just a technical alternative, but a strategic corporation with outside participants. In this point of view, a tight contract such as a service level agreement (SLA) has been considered as more effective and important contract mechanism, where an incentive is a significant factor. The incentive consists of a positive incentive as a reward and a negative incentive as a penalty. However, in the real SLA for IS outsourcing, incentive could not be fully reflected. At most, it has been treated as given or implicit factor of contract price because it is hard to analyze in an empirical or mathematical basis how such incentive affects in the world. With these comments serving as the backdrop, a computation model using exponential utility functions is introduced in this study to solve outsourcer’s decision problem with the choice of a proper incentive mechanism. By using the proposed model, we evaluate the possible incentive mechanisms in the side of outsourcer and verify several valuable propositions that came from the previous literatures and model. Consequently, we can induce the following incentive strategies for IS outsourcing contract. Offering incentive can provide better utility for outsourcer, but the outsourcer has to find a proper incentive level because the more incentive could not always guarantee the better utility. Linear incentive mechanisms that offer incentive in proposition to the vendor’s performance can induce better utility of outsourcer than offering fixed incentive. In the case of risk-averse outsourcer, he prefers an incentive contract with penalty. Considering the minimum contracted performance level, outsourcer has to decide a proper level and incentive ratio as well.