Db Toys 351u6b

Summary: DB Toys is a second tier toys based in Massachusetts with sales in more than 15 countries. In 2000 DB toys recorded net sales of 1.5 billion, down from 1.7 billion in 1999 Company was losing its market share and its total annual sale was dropping at a fast rate. IT department was spending $30 million on supply chain which was half of IT budget. This was way above industry standards. Company was looking for a way to reduce its supply chain costs by outsourcing its supply chain activities to Inflection which is supply chain consulting and service company

Q) What is the value proposition that Inflection brings to DB Toys The total IT budget of DB Toys is around $60 million. (50% of the entire IT budget, i.e. $30 million is spent on Supply Chain). The intention of the company is to reduce the IT expenditure towards the supply chain, which is above the industry average. Inflection Consulting made an analysis and found out the inefficiencies in the existing Supply Chain. DB Toys resources were only focused in the maintaining the status quo rather than improving the systems. Inflection Consulting brings two proposals with three options in each for reducing the expenditure as well as for smoothing the entire operations by outsourcing the business applications or business process. Inflection Consulting claims that, by just outsourcing the Business Application reduces the IT Supply Chain Expenditure by 20% a year. The same man power can be utilized for some other business operations to make the entire operations a success. Inflection Consulting suggested a design-build-run model that outsources the entire business process that enhances the entire business process in a professional way that can reduce the overall expenditure and increases the overall efficiency.   

Lowered costs in total. Changing fixed costs to Variable costs based on Variable pricing Out sourcing an activity which is not the firms core competency Helping executive management to focus on the bottom line

Q) Which Option should DB Toys choose? From Exhibit 10 it is found that, Weakness of DB Toys is in Supply chain (60% of the expenses are spent). Industry average is only 25% Therefore immediate benefit can be seen in "Business application outsourcing”, where Inflection can bring in efficiencies and thus reduce IT spending by 20% each year. "Business process outsourcing" is a risky as it requires an investment of $ 28 million per year (almost equal to current spending of $ 30 million) and financial impact of the improvements remains to be tested such as less order time, less inventory etc.,

Q) Which Pricing option is most advantageous? 1) Fixed Price Contract: ADVANTAGES  

Any risks associated with Project delays and costs are incurred by outsourcing partner Relatively Quick and easy to implement

DISADVANTAGES  

Option 1: Fixed Price $9.3 million/Quarter (i.e. 37.2 million annually). This is much higher than current spending of $ 30 Million Option 2: Fixed Price $11.7 million/Quarter (i.e. 46.8 million annually)

2) Cost-Plus Contract: ADVANTAGES 

Out sourcing partner will try to reduce the costs over time

DISADVANTAGES   

Fixed Price 9.3 million/Quarter (i.e. 37.2 million annually). This is much higher than current spending of $ 30 Million. There will be annual reduction of 2% Base fees will fluctuate with annual cost incurred by the vendor Outsourcing partner may not choose to strategic improvements due to prohibitive costs

3) Transaction based Contract: ADVANTAGES 

Clients with minimal cash flow prefer this option as no upfront payment is required

DISADVANTAGES  

Cost will be 0.75 million*55 = 41.25 million per quarter (Option1) 41.25million*4 = 167 million per year Cost will be .75 million*62 = 46.5 million per quarter (Option 2) 46.5 million*4 = 186 million per year

(Refer to Exhibit 9)

4) Fixed Price with annual shareholder value incentive clause: ADVANTAGES  

Incentive to perform will be higher Outsourcing cost will still be 4.88 million higher compared current spending, but better than just having a fixed price

DISADVANTAGES  

Cost will be 37.2 million*0.4 =14.88+ 5*4 = 34.88 million (assuming 0.05 increase in EPS based on revenue growth and operating cost cuts) Cost will 14.88+ 3*4 = 26.88 million (if only 0.03 increase in EPS is taken in to consideration)

5) Transaction based pricing with annual shareholder value incentive clause: ADVANTAGES 

Initial investment is nil, payments can be made as and when company generates value

DISADVANTAGES  

167million*0.4+5*4=86.8 million (assuming 0.05 increase in EPS based on revenue growth and operating cost cuts) 186million*0.4+5*4=94.4 million (assuming 0.05 increase in EPS based on revenue growth and operating cost cuts)

"Fixed price model with annual share holder incentive clause" can be most suitable contract which could cost less than the current IT spending of 30 million in Supply chain services

Q) What are the Strategic risks in outsourcing for each option?        

Not clearly defining goals and objectives before starting the outsourcing process Making the decision to outsource without complete information on internal costs and processes. Not considering the impact of outsourcing on other functions and areas of risk such as environmental and regulatory factors Not searching for potential providers of the service, and thus missing good candidates. Not considering the full impact of an outsourcing agreement on a company's financial condition Not establishing an outsource relationship that has sufficient flexibility to deal with business fluctuations Initiating an agreement with a service provider that limits flexibility in the future Continuous Improvement can be in jeopardy.