Determine the present worth of outsourcing

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Reference no: EM131374859

SoftWaire Inc., a United States-based software development company, is contemplating outsourcing a portion of its operations to Bangalore, India. The primary attractions for SoftWaire are the lower salaries in India and the availability of English-speaking engineers. The average salary of the 20 people they are thinking of replacing with an offshore operation is US $75 000 per year, while the salary of a comparable engineer in India is 600 000 rupees. With an exchange rate of 40 rupees per dollar, the salary costs in India are about 20% of what they are in the United States. This could bring substantial savings to SoftWaire; however, there appear to be numerous uncertainties associated with outsourcing. You have been asked to conduct an analysis so SoftWaire Inc. can better understand the potential benefits and risks of the project. Based on your initial data gathering, you have found the following information.

1. The salaries of software developers in India are indeed lower than those in the United States, however, demand from other local and international employers is strong and is causing salaries to increase at a rate of 10%-15% per year, with some forecasts as high as 20% per year. By comparison, American salaries are expected to grow at a rate of roughly 5 % per year.

2. Due to the high level of competition for good software developers in India, there is a high turnover rate in the industry. Estimates run from 20% to 30%. Th e American market is stable by comparison.

3. Most foreign companies use the services of a recruiter to find suitable employees. Recruiters typically charge a fee of about 30% of the salary of the successful employee to solicit applications, screen candidates, and present alternatives for final selection.

4. Training costs for new employees in their first year can be up to 70% of their salary for education in best practices and procedures used by the employer. Their productivity is typically about 50% of a trained employee's due to the learning process.

5. For development outsourcing to be successful, other firms report that they spend considerable time ensuring that software specifications are precise, that quality assurance procedures are clearly spelled out and followed, and that developers adhere to best practices. The cost of this additional project management has been estimated to add 10%-20% to salary costs.

6. Periodic problems with infrastructure and cultural differences have been reported to reduce overall development productivity to about 70% of that in the United States.

7. Setting up an outsourced team can entail considerable start-up costs. Travel, recruiter selection, facilities selection, and equipment installation for a team of 20 can range from S300 000 to $500 000.

8. SoftWaire would lay off 20 software engineers at the start of the project. This will cost one year's salary per person.

9. Office space lease costs will be roughly the same whether SoftWaire outsources or not.

10. SoftWaire uses a ALARR of 25 %.

11. The American dollar has fluctuated against the Indian rupee in recent years, and there is some concern that the rupee may strengthen against the dollar by as much as 10% in coming years.

You have decided to set up a spreadsheet to help with your analysis. From the information above, you plan to use the following as variables in a sensitivity analysis:
(1) salary growth rates for both American and overseas software developers,

(2) turnover rate of overseas employees,

(3) overseas recruiting costs, as a percent of salary,

(4) training costs, as a percent of salary,

(5) productivity rate of an employee in training,

(6) productivity rate of a trained employee,

(7) additional project management costs, as a percent of salary,

(8) SoftWaire's MARR,

(9) the exchange rate between the rupee and the American dollar (currently 40 rupees per dollar) and

(10) start-up costs.

(a) Construct a spreadsheet with the above variables to project the costs of outsourcing for a study period of 10 years. Start with the basic projected salaries, and adjust for recruiting and training costs, then for training and long-term productivity costs, and finally for project management, start-up, and layoff costs. Assume that the overseas developers are hired at time zero. When a range of values has been given for a variable, use the midpoint as the base case.

(b) Determine the present worth of outsourcing.

(d) What is the present worth of the benefits of outsourcing?

(e) Using the spreadsheet, conduct a sensitivity analysis for each of the uncertain factors, varying each factor by 10% to determine which has the greatest impact on the present worth of the benefits of outsourcing.

(f) What factors have the greatest impact on the present worth of the benefits of outsourcing? What would you advise at this point?

(g) At what exchange rate would the present worth of outsourcing be zero?

(h) At what productivity rate would the present worth of outsourcing be zero?

(i) Drawing on specific examples from this problem, describe some of the drawbacks of sensitivity analysis when making the decision to outsource or not.

(j) Formulate what you think would be a worst-case, expected, and best-case scenario for SoftWaire in terms of whether outsourcing is a good decision or not. W nat are your recommendations based on the information you have? If you could invest in obtaining better parameter estimates, which ones would you pick, and why?

Reference no: EM131374859

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