ROI Formula
"…don't own a cafeteria: let a food company do it! Don't run a print shop: let a printing company do that. Understand where your real value added is and put your best people and resources behind that."
- Jack Welch (former Chairman & CEO - General Electric in his book "Straight from the Gut")
A quantified analysis listing the typical non-core activities your business handles on a daily basis can help evaluate the "outsourcing decision making process." The following example will provide a framework from which a risk vs. reward determination can be made regarding the cost of outsourcing a business process.
First, Determine The Variables
NE = Number of Employees involved in task
AS = average Annual Salary of individuals performing the task ($/year)
TS = estimated Time Spent on the task each month (hours/month)
CA = annualized Cost of Alternative solution ($/year)
Determine The Estimated Annual Benefit Cost
Next, determine the estimated Annual Benefit Cost (ABC) by multiplying average Annual Salary (AS) by a factor of .35 (35% represents the industry standard of 35 cents of benefit costs for every dollar of employee wages):
ABC = $50,000(example) * .35 = $17,500/year
The average Total Compensation (TC) includes both AS and AB, or:
TC = $50,000 + $17,500 = $67,500/year
Assuming a 40-hour workweek, the Hourly Rate of the employee (HR) is calculated as follows:
HR = $67,500 / (52 weeks/year * 40 hours/week) = $32.45/hour
Total Time spent annually (TT) is estimated in Time Spent per month (TS):
TT = 20 hours/month * 12 months/year = 240 hours/year
The total Labor Cost per year (LC) to accomplish the task is then calculated by multiplying TT by Hourly Rate (HR):
LC = 240 hours/year * $32.45/hour = $7,788/year
In addition to the Labor Cost, one must consider the average cost associated with errors. The estimated Error Rate (ER) is found by multiplying the Number of Employees (NE) by the National Average in employer costs for such errors per employee ($3300/year) times the National Average error rate (3%) as follows:
ER = 300 employees (example) * ($3300/employee/year * .03) = $29,700/year
Finally, once one has these main components for reconciling the costs of handling the task in-house, a company can determine the Annual Total cost by adding the Labor Cost (LC) to the cost due to Error Rate (ER):
AT = $7,788/year + $29,700/year = $37,488/year
Now, Take A Look At The CA Alternative
The annual Outsourced Cost (OC) is calculated by multiplying the new Time spent after Outsourcing (TO) (here ½) by the comparative Hourly Rate of an in-house employee (HR) times the number of months in a year:
OC = $32.45/hour * .5 hours/months * 12 months = $194.70/year
Adding the annualized Cost of Alternative (CA) (charged by the provider) by the annual Outsourced Cost (OC) can determine the Total Costs due to Outsourcing (TCO):
TCO = $15,000/year (example) + $194.70 = $15,194.70/year
It is now possible to visualize the Outsourcing Savings (OS) by subtracting the Total Costs due to Outsourcing (TCO) from the Annual cost of the Task in-house (AT):
OS = $37,488 - $15,194.70 = $22,293.30/year
The company's Return On Investment is over $22,000 annually for an "average" employee. This exercise can help your company determine:
- Whether activities currently provided in-house provide a satisfactory return on investment;
- Which activities are most beneficial for your business to outsource;
- What rate from a BProcess Firm will adequately increase return;
- How to best present such an alternative in terms officers or management will easily understand;
*This Outsourcing formula is modified and abridged from an article written by Mikio Manuel and published in January 2004. Mikio is a regional HR consultant for ADP, Inc. and an Advisory Board member of SHRM's HRTX.
Why Point 1 Solutions?
Point 1 Solutions provides business management solutions including organizational design, strategic planning, business planning, and financial planning — a variety of business solutions that help your company succeed.