Step 1: Calculate the total annual in-house cost.
- Salaries: 2 administrators × $45,000/administrator = $90,000
- Software License: 5,000
- Overheads: 20% of salaries = 0.20 × 90,000=18,000
- Total In-house Cost: 90,000+5,000 + 18,000=∗∗113,000 per year**
Step 2: Calculate the total annual outsourcing cost.
- Monthly Cost: 500 employees × $15/employee = $7,500 per month
- Total Outsourcing Cost: $7,500/month × 12 months = $90,000 per year
Step 3: Compare costs and calculate annual savings.
- Annual Savings: Total In-house Cost - Total Outsourcing Cost
- Annual Savings: 113,000−90,000 = **23,000∗∗
- Percentage Saving: (23,000/113,000) × 100% ≈ 20.35%
Step 4: Recommendation.
Based on the financial analysis, outsourcing the payroll function is recommended as it would generate an annual saving of **23,000∗∗.
Evaluation:
Payroll is a non-core, administrative function, making it an ideal candidate for outsourcing. This allows management to focus on core competencies like production and product development. However, the decision should not be based on cost alone. The firm must:
- Vet the provider: Ensure the outsourcing firm is reputable and has strong data security protocols.
- Establish an SLA: Create a detailed Service Level Agreement (SLA) to define performance metrics, such as payroll accuracy and timeliness.
- Manage the transition: Consider the ethical and financial implications of making two employees redundant (e.g., redundancy payments, impact on morale).
Despite these risks, the significant cost saving and the non-core nature of the function make outsourcing a strategically sound decision, provided the risks are carefully managed.