A Knowledge-Based Perspective on Contract Choice in Application Outsourcing

A key governance decision in application outsourcing projects is the choice between fixed-price and time-and-materials contracts. While existing research draws on economic theories to explain contract choice, knowledge-based perspectives on contract choice remain underdeveloped. In this paper, we formulate and empirically test such a knowledge-based perspective. We argue that different contract types (fixed-price versus time-and-materials) assign the primary responsibility for coordination to different parties (vendor versus client) and that the ability of each party to coordinate the work depends on task characteristics. Specifically, vendors are most able to coordinate work when knowledge specificity is low and when task scope is high. Data on 1035 contract choices at 223 clients support these ideas. Fixed-price contracts are more frequent under low knowledge specificity and under high task scope. Our key contribution lies in formulating and empirically substantiating a knowledge-based perspective on contract choice.