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Weighing the costs of outsourcing.

Many companies unhappy with the steep costs of data processing technology are outsourcing their information systems (IS). However, thorough cost-benefit analysis may show that outsourcing is not financially sound for every company. For example, Avon Products, Inc., decided not to outsource after it found it would save less than 5% of its current costs.

When evaluating outsourcing alternatives, prepare a cost-benefit analysis that includes a review of

* The potential gains anticipated for each function being considered for outsourcing.

* The costs and possible risks of each outsourcing alternative.

* The appropriate contract period, including the first and any subsequent periods.

* Intangibles and hidden costs, such as those involved in administering the outsourcing contract and coordination efforts between internal users and the outsourcing company for upgrades, training and configuration changes.

* Contracting and legal costs, including the monetary and opportunity costs involved in contracting, renegotiating or vendor dispute settlements.

* The vendor's fee for each year of the contract periods. Consider the possibility of initial vendor low-balling when making projections for periods after the initial contract. Also, consider adjusting the outsourcing fee according to the cost-of-living index.

* Conversion costs. It is important to investigate in detail the costs associated with the transfer of software licenses, which often run into the thousands of dollars and may exceed any projected cost savings from outsourcing.

* Information systems salaries and severance payments. Consider the salaries of staff who are to be retained and payments required for employees who are to be terminated. In addition, legal costs could arise from disgruntled employees who may sue the organization.

* Cash. Compare the cash generated from the sale of computer hardware and fixtures and the reduction in cash requirements once the vendor has taken over obligations for lease payments, hardware maintenance, software support contracts and training.

* Customer service. Measure the projected gains from an enhanced strategic position and the ability to provide better service to customers.

* Contract cancellation. How much would it cost if the organization had to take over information systems in an extreme situation.; The costs associated with cancellation should include those required to negotiate a new outsourcing agreement or to hire and train new staff and, when appropriate, replacing hardware and software owned by the outsourcing vendor. These costs should be explicitly set out in the outsourcing contract.

* Staff morale. Morale problems of in-house personnel could lead to lower productivity.

* Share price. Will the announcement of the outsourcing decision hurt stock prices?

COPYRIGHT 1996 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1996, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Publication:Journal of Accountancy
Date:Sep 1, 1996
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