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2. Business Decision Logic

It is virtually impossible to develop a listing of every type of business decision you will confront. Classic examples include whether to outsource or not, when to accept special orders, and whether to discontinue a product or project. Although each of these examples will be considered in more detail, what is most important is for you to develop a general frame of reference for business decision making. In general, that approach requires identification of decision alternatives, logging relevant costs/benefits of each choice, evaluating qualitative issues, and selecting the most desirable option based on judgmental balancing of quantitative and qualitative factors. As you reflect on this process, recognize that it begins with judgment (what are the alternatives?) and ends with judgment (which alternative presents the best blend of quantitative and qualitative factors). Analytics support decision making, but they do not supplant judgment.

2.1. Outsourcing

Companies must frequently choose between using outside vendors/suppliers or producing a good or service internally. Outsourcing occurs across many functional areas. For instance, some companies outsource data processing, tech support, payroll services, and similar operational aspects of running a business. Manufacturing companies also may find it advantageous to outsource certain aspects of production (frequently termed the "make or buy" decision). Further, some companies (e.g., certain high profile sporting apparel companies) have broad product lines, but actually produce no tangible goods. They instead focus on branding/marketing and outsource all of the actual manufacturing. Outsourcing has been around for decades, but it has received increased media/political attention with the increase in global trade. Tax, regulation, and cost factors can vary considerably from one global region to another. As a result, companies must constantly assess the opportunities for improved results via outsourcing.

The outsourcing decision process should include an analysis of all relevant costs and benefits. Items that differ between the "make" alternative and the "buy" alternative should be studied. As usual, avoid the temptation to consider sunk costs as part of the decision analysis. Generally, one would compare the variable production/manufacturing cost of a service/product with the purchase price of the service/ product. Unless the outsourcing option results in a complete elimination of a factory or facilities, the fixed overhead is apt to continue whether the service/product is purchased or produced. As a result, unavoidable fixed overhead does not vary between the alternatives and can be disregarded. On the other hand, if some fixed factory overhead can be avoided by outsourcing, it should be taken into consideration as a relevant item.

2.2. Outsourcing Illustration

Pilot Corporation produces software for handheld global positioning systems. The software provides a robust tool for navigational support and mapping. It is used by airline pilots, mariners, and others. Because these applications are often of critical importance, Pilot maintains a tech support department that is available around the clock to answer questions that are received via e-mail, phone, and IM. The annual budget for the tech support department is shown below. Direct labor to staff the tech support department consists of three persons always available during each 8-hour shift, at an hourly rate of $12 per hour (3 persons per shift x 8 hours per shift x 3 shifts per day x 365 days per year x $12 per hour = $315,360). The utilities and maintenance are fixed, but would be avoided if the unit were shut down. The building is leased under a long-term contract, and the rent is unavoidable. Phone and computer equipment is leased under a flat rate contract, but the agreement is cancelable without penalty. The annual depreciation charge on furniture and fixtures reflects a cost allocation of expenditures made in prior years.

Direct labor $ 315,360

Utilities and maintenance 40,000

Building rent 120,000

Phone/computer leasing 60,000

Annual depreciation of furniture and fixtures 100,000

$ 635 360

Pilot has been approached by Chandra Corporation, a leading provider of independent tech support services. Chandra has offered to provide a turn-key tech support solution at the rate of $12 per support event. Pilot estimates that it generates about 50,000 support events per year. Chandra's proposal to Pilot notes that the total expected cost of $600,000 (50,000 events x $12 per event) is less than the amount currently budgeted for tech support. However, a correct analysis for Pilot focuses only on the relevant items (following). Even if Chandra is engaged to provide the support services, building rent will continue to be incurred (it is not relevant to the decision). The cost of furniture and fixtures is a sunk cost (it is not relevant to the decision). The total cost of relevant items is much less than the $600,000 indicated by Chandra's proposal. Therefore, the quantitative analysis suggests that Pilot should continue to provide its own tech support in the near future. After all, why spend $600,000 to avoid $415,360 of cost? Once the building lease matures, the furniture and fixtures are in need of replacement, or if tech support volume drops off, Chandra's proposal might be worthy of reconsideration.

Direct labor $ 315,360

Utilities and maintenance 40,000

Building rent 120,000

Phone/computer leasing 60,000

Annual depreciation of furniture and fixtures 100,000

$ 415,360

 
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