Outsourcing, Part 3

Knowing what costs to expect can help avoid budget-busting surprises.

In the August 24 issue of CAD Manager’s Newsletter I continued my series on outsourcing by identifying the business factors that affect your company’s decision-making process. In this issue I’ll give you a hypothetical example of a company considering outsourcing and show how you can use good, old-fashioned ROI (return-on-investment) methodologies to make a go or no-go decision.

Sample Case

Our sample case involves a company, called XYZ Engineering, that is considering moving its CAD operations from its United States offices to an offshore facility. The basic proposal is as follows:

The work of four  CAD operators employed on an hourly basis at an average rate of $19 per hour (inclusive of pay, taxes, etc.) is being outsourced to a foreign service bureau that charges $8 per hour for similar CAD services.

To facilitate the outsourcing, a drafting/design checker who also acts as a job manager must be employed at $25 per hour on a half-time basis to make sure that all the work is done accurately and that everything flows smoothly. This person will be the liaison between the U.S. operations and the outsourced firm.

The company further estimates that accounting and legal costs of keeping track of invoicing, compliance, intellectual property and so forth will require the equivalent of 80 hours per year for accounting and 40 hours per year for legal services.

Setting up the arrangement is estimated to require 80 hours of legal resources for initial contracts, 80 hours for accounting setup and 120 hours of training to be provided by the new checker/job manager for the outsourcing company.  To accomplish the startup, three staff members will be expected to visit the outsourcing company’s offices for two weeks.

Let’s examine the plan by crunching the numbers and see what happens.

Labor Savings

 The labor savings in this case is simply the cost differential for the hourly CAD labor. I’ll assume 40 hours per week, per operator, and a 48-week work year for my computations. The labor savings is merely the difference between the in-house rate and the outsource rate as shown below:

Hourly labor savings: $19/hour - $8/hour = $11/hour

Annual labor savings: 40 hours/week x 48 weeks/year x 4 workers x $11 = $84,480

New Costs

The savings obtained via cheaper CAD labor must now be balanced by the managerial, legal and accounting expenses required to track and monitor the outsourcing process. Remember that there will be both startup costs and ongoing annual costs. Below are the new costs that will be introduced.

Drafting/design checking and job management costs.
Hourly startup cost: 120 hours x 1 worker x $25/hour = $3,000

Startup travel cost: 1 worker x $3,000 = $3,000

Total startup cost: $3,000 hourly labor + $3,000 travel = $6,000

Annual cost: 20 hours/week x 48 weeks/year x 1 worker x $25/hour = $24,000

Remember that this is a half-time position that will require an experienced (and therefore more highly paid) staffer to be diverted from other responsibilities.

Accounting costs.
Startup accounting costs: 80 hours x 1 worker x $30/hour = $2,400

Annual accounting costs: 80 hours/year x 1 worker x $30/hour = $2,400

Legal costs.
Startup legal costs: 80 hours x 1 lawyer x $200/hour = $16,000

Annual legal costs: 40 hours/year x 1 lawyer x $200/hour = $8,000

Senior staff and travel startup costs.
Travel for two more persons: $3,000/trip x 2 workers = $6,000

Staff time for executive level personnel: 40 hours x 2 executives x $75/hour = $6,000

Summing Up

Now let’s see how it all adds up:

 * Note that labor cost is not included here because it has been factored into the annual savings, which will be used to compute investment return.

So now let’s look at years one and two and ongoing financial analysis using a plain-English approach. In year one this company will have to spend $70,800 dollars in startup and annualized costs to yield $84,480 in savings, yielding a return on investment of 19% (simply divide $84,480 by $70,800 and then convert to percentage).

In years two and beyond, the company will be able to achieve an $84,480 annual labor savings by spending $34,400, thus yielding a return on investment of 145%. So you see that getting outsourcing set up won’t yield immediate savings; it is only in the successful long-term implementation of outsourcing that savings are realized.

Drawing Conclusions

There are so many conclusions that we can draw from our sample analysis that I want to continue this topic for one more issue of the newsletter. I hope that you can now see how to quantify outsourcing costs and savings and that you can view the process as the accountants and business types do.

In the next edition of the newsletter I’ll draw a number of business and technical conclusions from the sample case presented in this issue.

P.S. Send your outsourcing stories, good or bad, to me at rgreen@greenconsulting.com.