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Outsourcing at Office Supply Inc Case Solution

Solution Id Length Case Author Case Publisher
1087 1379 Words (5 Pages) Mark Jeffery, James Anfield, Subhankar Bhowmick Kellogg School of Management : KEL308
This solution includes: A Word File A Word File and An Excel File An Excel File

OSI is experiencing stagnancy in the revenues. In order to cater to the needs of its customers, OSI has decided to outsource its IT infrastructure. TSI has offered a deal, but the actual financial output of the deal is still to be computed. The base case calculations show that OSI will incur a total cost of $372 million in the five years. If the IT infrastructure is outsourced to TSI, the cost comes out to be $342 million representing $29.6 million of savings. This 8 % of savings do not meet the criteria set out by OSI. However, the total contribution and operating margin of 19.81% 12.61% respectively is above the requirements of TSI. Efficient negotiations on the part of TSI can point towards the potential benefits of the project.

Following questions are answered in this case study solution

  1. What are the outsourcing cost savings for OSI? Do the savings meet OSI’s requirements?

  2. What is the profitability of the OSI deal for TIS? Does it meet the contribution margin and operating profit acceptability criteria for TIS?

  3. What are the drivers of value in the deal?

  4. What would you change to make it more of a win-win for both parties?

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Case Analysis for Outsourcing at Office Supply Inc

1. What are the outsourcing cost savings for OSI? Do the savings meet OSI’s requirements?

In order to calculate the costs for both cases (base case and the outsourced case), the following formula is used.

Costs = FTE + Hardware Costs + Software Costs + Migration Costs + Services Costs + Facilities Costs

The FTE costs include the costs of salary, overtime, benefits and other related overheads. The costs of hardware constitute the hardware capital expenditures plus any maintenance costs required by it. Similarly, the cost of software also comprises of capital outlays and maintenance costs. Migration costs include transportation expenses, training expenses for the employees, retention bonuses and, etc. There are three main heads for the service costs namely the network, disaster recovery, and the related corporate overhead. There is no overhead in the scenario of outsourcing. The facility's expense mainly consists of floor expenses. The base case calculations show that OSI incurs a total cost of $371.866 million in the coming five years. The annual costs of OSI are between $70 million and $80 million. On the other hand, the savings analysis shows that in the scenario of outsourcing, OSI will incur total costs of $342.259 million. From the initial observation, it can be implied that OSI is benefited from the decision of outsourcing as the total costs it encounters, in this case, are far below than the base case costs. The actual cost savings come out to be $29.6 million.
The following formula is used to compute the percentage of costs savings:

Cost Savings Percentage = ($371.88 - $342.26) / $371.88 * 100 = 7.96% Approximately

As per the requirement of OSI, the minimum cost savings should stand at 10%. From this perspective, the outsourced savings do not fulfill the requirement of OSI. Additionally, OSI also desired to realize a major portion of the cost savings in the first year of operations. The data on cost savings shows that the first year depicts a negative cost savings of $13 million. This figure of negative savings is quite substantial when the overall cost savings of $29.6 million is taken into account. In this regard, the outsourcing decision does not fulfill either of the two prescribed requirements of OSI.

2. What is the profitability of the OSI deal for TIS? Does it meet the contribution margin and operating profit acceptability criteria for TIS?

The profit and loss account of TSI (Exhibit 15) shows that TSI will consistently retain profits in the five year period. The following table shows the individual profitability of the five years and the consolidated profitability figures.

TSI Profitability

 

Year 1

Year 2

Year 3

Year 4

Year 5

Total

Total Revenue Outsourcing

 $ 84,970,899.55

 $ 59,888,571.16

 $ 82,417,985.72

 $ 56,736,837.68

 $ 58,245,135.41

 $ 342,259,429.51

Total Direct Expenses

 $ 70,699,902.55

 $ 47,955,737.23

 $ 61,117,548.41

 $ 46,827,800.01

 $ 47,843,767.76

 $ 274,444,755.97

Contribution Margin

 $ 14,270,996.99

 $ 11,932,833.93

 $ 21,300,437.30

 $ 9,909,037.67

 $ 10,401,367.65

 $ 67,814,673.55

Contribution Margin %

16.80%

19.93%

25.84%

17.46%

17.86%

19.81%

Operating Profit

 $ 8,162,566.65

 $ 7,338,439.90

 $ 15,539,215.03

 $ 5,841,034.90

 $ 6,286,988.39

 $ 43,168,244.86

Operating Profit %

9.61%

12.25%

18.85%

10.29%

10.79%

12.61%

The contribution margin is highest in the third year of operations, and as predicted by the migration and other related expenses, it is minimum in the first year of outsourcing. TSI, even after including huge migration expenses in the first year, manages to attain 16.18% gross profit. As per the requirement or constraint of TIS, the gross or contribution margin over the life of the deal should exceed 16%. The final figure shows that over the life of the deal, TSI will experience a contribution margin of 19.81%. Hence, the project is quite lucrative from this perspective. TSI also places a limit on the operating profit percentage. According to TSI, the minimum total operating profit percentage for the deal should exceed 8%. The calculations depict that the project/deal outputs a consolidated operating profit margin of 12.61% which is substantially higher than the given constraint. Therefore, the TSI’s criteria for contribution margin and operating profit are both met.

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