Procurement of IT Consulting Services and Firm-Specific Characteristics1

Article excerpt

Abstract

Information technology investments and the management consulting industry witnessed unprecedented growth in the last decade. This led to regulators' (SEC and Congress) allegations that consulting services that are provided by incumbent auditors may be disguised extra payments to auditors for favorable financial reporting. However, there may be alternative valid reasons for procurement of consulting. Under new legislation (proclaimed in the aftermath of spectacular failures like Enron and Worldcom), publicly traded corporations that engage professional services firms to provide both audit services and consulting services must now disclose the extent and nature of these services. Using the data made available by these new mandated disclosures and using the theoretical backdrop of the resource-based view (RBV), this paper examines whether investments by firms in consulting services follow predictable patterns driven by economic factors. Thus, rather than examine whether IT consulting has any ex-post value or whether procurement of consulting impairs auditor independence, this study focuses on whether investments, ex-ante, follow logical patterns consistent with microeconomic principles. Our analysis shows that procurement of IT and management consulting is consistent with the resource-based view -companies seek to develop organizational capabilities they lack as dictated by their strategic business need. In contrast to the narrow "IT Doesn't Matter" view, it can be argued that even in the current environment of IT outsourcing, firms must carefully match their IT capability (in-house or outsourced) with organizational strategy and capability to develop unique and inimitable resources as put forth by RBV. We find that companies are indeed investing consistent with fundamental tenets of financial value analysis and based on market expectations of performance. More specifically, after controlling for pressure to perform and cash availability, low margin and low turnover companies spend more on consulting services. Low-margin strategy companies expend more on consulting when their asset turnover is also low, while low-turnover strategy companies expend more on consulting when their earnings margin is also low.

Keywords: Resource-based view, Sustainable competitive advantage, Sustainable growth rate, IT consulting, Firm performance

(ProQuest Information and Learning: ... denotes formulae omitted.)

Introduction

The last decade ushered in an era of rapid growth in the global consulting services industry. Some estimates show that the worldwide market for management consulting is worth $100 billion, having grown from less than $10 billion only a decade ago (Management Consultancies Association website, www.mca.org.uk). Other reports suggest management consulting is expected to top $125 billion by the end of 2005 (BusinessWeek, 2004). In addition, worldwide information technology (IT) spending (not just consulting) reached $965 billion in 2004 and is expected to increase at a compound annual growth rate of 6% from 2004 through 2008 to $1.2 trillion. In the U.S. alone, IT spending was expected to reach $416 billion by 2005 year-end (IDC Analysts, 2005). As investments in management consulting and IT have increased, so also have the number of research studies examining if and under what conditions these IT and consulting investments yield positive returns. IT and management consulting expenditures are different from IT investments in building hardware and software infrastructure. Consulting is meant to identify and build unique and non-imitable resources that enable firms to become competitive and sustain this edge, consistent with Barney (1991) and the resource-based view (RBV) discussed in the following paragraphs. While investment phenomena of such sustained magnitude (over a decade) invite inquiry, research to date has been held back by a lack of data sources containing all the desired (relevant) variables. …