Applications of real option analysis to vendor selection process in IT outsourcing

Information technology (IT) outsourcing is one change management issue facing organisations in today's rapidly changing business environment. Due to its very nature of uncertainty, it is critical for companies to manage and mitigate the high risks associated with change management including the task of vendor selection in IT outsourcing practices. In this study, we explore a two-stage vendor selection approach to IT outsourcing using real options analysis (ROA). In the first stage, the client engages a vendor for a pilot project and observes the outcome. Using this observation, the client decides either to continue the project to the second stage based upon pre-specified terms or to terminate the project. A case example of outsourcing the development of supply chain management information systems (SCMSs) for a logistics firm is also presented in the paper. Our findings suggest that ROA is a viable valuation technique for IT outsourcing.