Question

What are the critical success factors for outsourcing according to the Bain & Company research discussed during this course’s lectures? Please show how to relate the following information to one of these critical success factors: a company’s processing work would need an in-sourced datacenter with annual fixed costs of $150,000 and variable costs of $100,000 for running the company’s work for a year, and outsourcing company’s datacenter that could process 100 times the company’s processing work had annual fixed costs of $800,000 and annual variable costs of $100,000 for running each company’s work.

Answer 1

Benefits of Outsourcing

• Reduce operating costs
• Instill operational discipline
• Expertise/innovation of specialized firms
• Encourages best practices
• Avoids capital investment
• Releases best people, capital and management time to focus on core competencies

Critical Success Factors for Outsourcing—Bain and Company

• Don’t outsource a core competence
• Outsource when there’s economy of scale that will yield a financial benefit
• Risk of undue dependency on the vendor?
• Gain from access to scarce skills
• Gain from focusing best people on core competence
• Contract with a qualified vendor
• Contract with clear economic and service requirements

Relating the Information to one of the Critical Success Factors

• Fixed costs grow with capacity, then fall when you go offshore
• Variable costs are fixed until you go offshore
• Average cost = Total Costs ÷ units of processing
• Total Cost ÷ Capacity in Units of work falls
• Total cost = fixed cost of $250,000 + variable cost of 1 unit x $100,000 = $250,000
• Total cost = fixed cost of $500,000 + variable cost of 50 x $100,000 = $5,500,000
• Total cost = fixed cost of $800,000 + variable cost of 100 x $100,000 = $10,800,000
• The total cost has gone up by $250,000 ÷ $10,800,000 = 43 times (While the units of work have gone up 100 times)
• So average cost (total cost capacity in units) falls from $250,000 ÷ 1 = $250,000 to $8,320,000 ÷ 100 = $83,200 per unit of work
• This is economy of scale: a success factor because your firm can realize a saving while your supplier is profitable