Outsourcing Customer Service Operations - Assignment Example

? Outsourcing Service Operations Introduction Outsourcing involves contracting out the business processes or operations carried out internally within the business to the local or foreign organizations, and it is popularly known as BPO or Business Process Outsourcing. The companies need to carefully analyze the advantages and disadvantages involved in outsourcing decisions. The reasons for outsourcing are multifarious, though the important determining factor being availability of cheap labor in the emerging economies. In the present case of GO Software Company the customer service operations are proposed to be outsourced from an Indian company. The cash flow from the operations proposed to be outsourced is analyzed to work out the net present value for evaluating the outsourcing decision of the company under various scenarios. Hypothesis Cost savings is an important determinant in the risk reward analysis of an outsourcing decision taken by a company. However, there are also other considerations involved such as tax implications, stringent statutory regulations and the conditions in the labor market. Labor productivity Since the decision proposed to be taken is mainly on the basis outsourcing labor involved in the operations, productivity of the labor need to be analyzed for comparison. Though currently the labor productivity in India is less compared to US, the company is hopeful of increase in productivity over a period of time due to training and experience as reflected in Scenario 2. Labor productivity Number of service calls per day : 600 Total number of calls during the year : 600 x 365 = 219000 Number of customers served in US/Hour : 10 Number of customers served in India/Hour : 6 Number of hours in US required/year : 219000 / 10 = 21900 Number of hours in India required/year : 219000 / 6 = 36500 Labor Cost The company aims at reducing the cost of providing service to the customers for maximizing its profits. Since the important determinant factor is cheap labor available in India which works out to just 20% of the wages prevailing in US, the overall cost of labor comes down in outsourcing. Estimated labor cost in US : 21900 x 10 = $219000 Estimated labor cost in India : 36500 x 2 = $73000 Investment in outsourcing The company estimates that all other costs associated with outsourcing customer service have a present value of $2 million. The annual rate of interest is considered at 5% for working out the net present value of the cash out flows over the expected future life of the business of 20 years under Scenario 1 and at 3% under Scenario 2 for 30 years. The net present values relating to operations in US and outsourcing to India under the two scenarios are given below. Operations in US Outsourcing to India Scenario 1 (20 years & Interest @ 5%) 2,729,224 2,909,741 Scenario 2 (30 years & Interest @ 3%) 4,292,497 4,126,214 It could be observed that under Scenarios 1, outsourcing appears to be not attractive. However, under Scenario 2 outsourcing to India is beneficial. The parameters adopted under Scenario 2 are applied for 20 years time horizon for the purpose of comparison (Scenario 3) as below. Scenario 3 (20 years & Interest @ 3%) 3,258,167 3,417,476 Outsourcing is not attractive under Scenario 3. In the case of Scenario 2, the reduction in cost through outsourcing is negligible considering the longer time horizon. The changes in Scenario 2 compared to Scenario 1 are analyzed to understand their impact on the outsourcing decision. Also, the recommendations are given after careful evaluation of the impact of the various important determinants involved in outsourcing decision. Recommendations Outsourcing under Scenario 1 does not result in cost savings in view of the initial investment outlay required to be made. The changes introduced under Scenario 2 also do not make the outsourcing decision attractive. Therefore, based on a careful analysis from different perspectives, outsourcing is not recommended due to the reasons given. However, outsourcing under Scenario 4 or Scenario 5 given below could be considered after carefully revisiting the interest rate structure. 1. Change in the time horizon The change in the time horizon to 30 years results in reduction of cost. However, the reduction in outsourcing cost works out to just $166283 or 3.87%. These savings in cost through outsourcing compared to the cost of operations in the US could be attributed to increase in demand for customer service over the period of time. The forecast too far into the future is fraught with uncertainties. Since increase in demand is the major determinant in the decision of outsourcing, the changes in demand pattern will vitiate the forecast. 2. Change in the interest rate The factor, reduction in interest rate to 3% does not work out in favor of outsourcing. If we apply 5% interest in Annexure-I under Scenario 2, present values would be 3,366,567 (US) and 3,600,110 (India) which makes outsourcing to India attractive. It is very important to note that interest rates in India are always higher in India compared to the US and cannot be lower. Therefore, we modify the scenarios 1 and scenario 2 to work out scenarios 4 and 5 respectively by keeping the interest rate at 3% in the US and at 5% in India. Scenario 4 (20 years & Interest @ 3% modifying Scenario 1 for US operations and 5% for outsourcing) 3,258,167 2,909,741 Scenario 5 (30 years & Interest @ 3% modifying Scenario 2 for US operations and 5% for outsourcing) 4,292,497 3,600,110 In both these cases outsourcing is attractive. It could be observed that the increase in the interest rates in India makes outsourcing attractive. 3. Increase in demand for customer service Increase in demand for customer service has increased the level of operations phenomenally and makes outsourcing attractive. The increase in demand for customer service is related to the increase in business. Though outsourcing under Scenario 2 results in cost reduction, the longer time horizon and the insignificant quantum of decrease in cost makes it less attractive. 4. Increase in productivity of Indian workers The increase in productivity of Indian workers contributes significantly for reduction in the cost as it increases the number of customers served from 6 to 25 approximately. However, the increase in productivity year over year as envisaged will be difficult to achieve year after year for 30 years under Scenario 2. Therefore, reduction of cost under Scenario 2 in the case of outsourcing is less reliable. 5. Increase in real wages of Indian workers The benefit derived from increase in productivity by 5% is offset by increase in real wages of the Indian workers by 5% year over year basis. The assumption with regard to increase in real wages in the case of India may not hold in view of high inflation in India. However, in that case, this assumption could be accepted as it could be compensated by depreciation of Rupee against US$. Limitations of the analysis Variation in the fixed and variable overheads involved in the operations could vitiate the estimates. Increase in productivity at 5% year over year could be achieved in the in the initial few years and may not be sustainable year after year up to 30 years. We have considered interest rate at constant level though the Interest rate cycle may change over a period of time. The overhead cost saved on account of shifting the operations to India is an important factor needs to be considered. For example, the details in respect of costs associated with space evacuated and reduction in administrative overheads resulting in outsourcing are not furnished. The increase in productivity by 5% is offset by increase in the real wage of Indian workers by 5%. It should be remembered that the position is not altered also in the case of labor cost in US, if we apply these changes relating to productivity and increase in real wages. Only labor cost should not guide the decisions in outsourcing. Schumpeter (2011) stated “Some of the worst business disasters of recent years have been caused or aggravated by outsourcing…Sometimes vendors overpromise in order to win a contract and then fail to deliver. Sometimes both parties write sloppy contracts. And some companies undermine their overall strategies with injudicious outsourcing. Service companies, for example, contract out customer complaints to foreign call centres and then wonder why their customers hate them.” Conclusion Based on the analysis the outsourcing is not recommended considering the reduction in cost through outsourcing which is not significant. However, under Scenario 4 and Scenario 5 outsourcing could be considered. However under the projections given, the differences in the other scenarios between operations in US and outsourcing to India are less than 5% only, which is negligible in view of the time horizon considered and the other variables which we have assumed. Outsourcing enables the management to concentrate on the core activities of the business. It is also important to take into account that the quality of service is not impaired in outsourcing. Though ‘cheap labor’ is an important factor in influencing the outsourcing decisions, the factors such as operational control, language and cultural background of the sub-contractors should be carefully considered in taking the outsourcing decisions. References Schumpeter. The trouble with outsourcing. The Economist, July 30, 2011. Appendix Annexure – I GO Software Company (Excel) Read More