Standard Financial Investment Information
In recent years many companies chose to at least partially outsource their IT operations. They are of the opinion that the IT is not the core competence of the company and outsiders who will undertake to provide the IT operation as outside contractors will do a better, and possibly cheaper job.
The financial manager must be able to assess the wisdom of the investment in technology, and in particular in IT, from the viewpoint of the shareholders. The basic question that one must try to answer is: would an investment in technology and IT raise the value of the shares and increase the wealth of the owners of the company - the shareholders? Would an outsourcing be more beneficial? Should the company lease (or outsource) these technologies or should it invest in developing new technologies? What impact would these decisions have on shareholders value?
In this module we will be considering this investment decision with reference to IT outsourcing and its relation to capital budgeting and risk. Please review at least in overall terms the following documents relating to IT outsourcing:
Thor Olavsrud (2011). IT Outsourcing. Datamation. Retrieved from http://itmanagement(dot)earthweb(dot)com/career/article.php/3875026/IT-Outsourcing.htm#IT_Outsourcing_Pros_and_Cons.
James Bucki (2011). Introduction to Outsourcing. About.com. Retrieved from http://operationstech(dot)about(dot)com/od/costsavingstrategies/a/OutSrcDefine.htm
James Bucki (2011). Top 7 Outsourcing Advantages. About.com. Retrieved from http://operationstech(dot)about(dot)com/od/officestaffingandmanagem/a/OutSrcAdvantg.htm
James Bucki (2011). Top 6 Outsourcing Disadvantages. About.com. Retrieved from http://operationstech(dot)about(dot)com/od/outsourcing/tp/OutSrcDisadv.htm
F. John Reh (2011). Offshoring - Outsourcing to Extreme. About.com. Retrieved from http://management(dot)about(dot)com/cs/people/a/offshoring104.htm
Dhanya Ann Thoppil (2011). IT Firms Split on Outsourcing Demand for 2011. IndiaRealTime. Retrieved from http://blogs(dot)wsj(dot)com/indiarealtime/2011/02/17/on-outsourcing-demand-for-2011-indian-it-is-split/
Also read these document discussing managerial decision-making concerning return on investment, capital budgeting and risk.
Cresswell AM. Return on Investment In Information Technology: A Guide for Managers Retrieved Sept. 23, 2007 from http://www(dot)ctg(dot)albany(dot)edu/publications/guides/roi
Graham J and Campbell H (2002) How Do CFOs Make Capital Budgeting And Capital Structure Decisions? Journal of Applied Corporate Finance. Retrieved Sept. 23, 2007 from http://faculty(dot)fuqua(dot)duke(dot)edu/~jgraham/website/SurveyJACF.pdf
In addition, read this overview of the lease vs. buy decision and this article on such decisions in IT.
Case Assignment
The background information has further material on using financial data to assess risks and comparatively evaluate the future possibilities for companies. In addition, you may wish to seek out further information through your own research. When you have reviewed the advice and the plans. please prepare a short (3-5 page) paper discussing:
Agree or disagree: Standard financial investment information and criteria are all that is needed to effectively evaluate IT outsourcing decisions. (When evaluating the options be sure to compare debt vs. equity)
Please carefully explain your reasoning, with reference to the appropriate financial and other information.
Assignment Expectations
Use information from the modular background readings as well as any good quality resource you can find. Please cite all sources and provide a reference list at the end of your paper.
LENGTH: 3-5 pages typed and double-spaced.
The following items will be assessed in particular:
- Your ability to demonstrate your understanding of the role of financial information in IT outsourcing decisions;
- Your ability to demonstrate your understanding of the advantages and disadvantages of debt and equity options.
- Some in-text references to modular background readings.
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Standard Financial Investment Information
To effectively evaluate IT outsourcing decisions, standard financial investment information as well as criteria is not all that is required. Other vital aspects also have to be taken into considering including environmental effects, goodwill to the community, availability of resource, employee morale as well as feasibility. Decisions to outsource are often made with the use of incremental, full costing or variable costing analysis. Variable or full costing basically entails the preparation of 2 side-by-side income statements and then comparing the dissimilarity in profit between the two (Bucki, 2011). The most effective method is incremental analysis given that it could be analyzed more quickly. It is also the easiest, the best and the shortest method since it assists managers to concentrate on the pertinent parts of a decision. Decisions to outsource are based upon the dissimilarity in the cost incurred to buy or purchase a service/product from an external supplier compared to the cost of providing the service or producing the product in-house (Bucki, 2011).
There are several outsourcing decisions that are noteworthy. First, in decisions to outsource, there are no incremental revenues. The decision to outsource is whether to pay an external entity to produce or to spend the costs inside the company to produce. Secondly, incremental costs include: (i) avoidable fixed costs – the fixed costs which will not be incurred by the firm if the decision to purchase or buy is made, or the costs that would be avoided in case a certain decision is made. In essence, these are the costs that the business organization would avoid if the product is not produced from within/internally (Bucki, 2011). (ii) Variable costs of production. (iii) Cost savings which occur because of outsourcing versus producing internally. For instance, if a business organization decides not to produce an item internally, then it would save several manufacturing costs which include fixed overhead costs, variable overhead costs, direct materials costs, as well as direct labor costs. (iv) Any opportunity cost which might occur if the organization decides to outsource rather than insource. It is notable that these costs are the amounts that are given up whenever a certain course of action is selected. For instance, if an organization chooses to produce externally, it may be able to rent out its space for manufacturing in order to generate rental revenue. This rental revenue is an important cash inflow in case the organization decides to outsource. However, it is an amount that the firm w...