Problem Definition
Your client, BusCo, is a passenger bus company in Uganda, Africa. Due to the poor road conditions, maintenance plays a very important role in the reliability and quality of BusCo’s services.
BusCo outsourced all of its bus maintenance operations to MaintainCo in the last years. However, especially last year, BusCo was very disappointed with the maintenance provided. The bad service caused delays in service as well as trip cancellations.
Now BusCo is considering doing its maintenance in-house. However, an investment amortization period of 4 years or less is required.
The CEO wants to know from you if they should pursue the in-house maintenance strategy next year?
Comments
This case does not require any complicated analysis of the industry (customers, market or competitors). However, it covers an issue, which is quite often faced by businesses all around the world. Should we do it in-house or should we hire someone to do it elsewhere (outsource)?
These problems always have two sides: a financial/economical side (measured in dollars) and a strategic side (difficult to translate into money/costs but as relevant as the economics).
The case does NOT require any specific framework. However, a very clear analysis structure should be laid out from the beginning of the case and followed throughout.
Remember, the interviewer wishes to measure how organized and structured the interviewee is.
Short Solution (Expand)
Detailed Solution
Suggested case structure:
I. Economic comparison
First, the economics regarding the change should be considered:
- Costs of in-house maintenance vs. outsourced costs
- Payback time of in-house alternative
At this stage, the interviewee should ask for the main costs that the
in-house maintenance would require. You should first request an estimate of the main costs of the maintenance operation.
- The required facilities can be acquired in two different ways:
- Scenario 1: Acquisition of the facilities
- Scenario 2: Renting the facilities
- Since the outsourcing costs are flat-rate per bus, we will also break down in-house costs per bus to be able to compare the two.
The candidate should be able to calculate costs for both scenarios.
Scenario 1
In Scenario 1 savings would be $1m per year.
The investment would pay off in 3.5 years and therefore be below the amortization limit of 4 years.
Scenario 2
In Scenario 2 savings would be $0.7m per year.
The investment would pay off in a bit less than 3 years, also below the payback limit stated.
II. Advantages/risks
This is a more subjective analysis of the change comparing advantages/opportunities against disadvantages/risks.
Scenario 1: In-house maintenance buying facilities
Advantages
- BusCo would possess a very valuable real estate asset (worth $1.5m). The investment would be paid back in 3.5 years.
- Less dependence of facilities contracts and less vulnerability to changes in price or even to cancellation of rent contracts on behalf of the facility owners.
Risks/disadvantages
- If the in-house maintenance does not work as expected (because of a number of reasons like lack of capabilities and expertise, lack of qualified work-force etc.), BusCo would see itself with a “useless” real estate asset that it would have to resell possibly for less than the purchasing price of $1.5 million.
Scenario 2: In-house maintenance renting facilities
Advantages
- More flexibility in case the in-house service does not work as expected. The facilities investment ($1.5 million) would not be required.
- Payback time would be better: less than 3 years against 3.5 years if buying facilities.
Risks/disadvantages
- If the in-house service works, then after 3.5 years the company would not own the facilities worth $1.5m as in scenario 1.
- Rent is very likely to increase after 5 years.
Scenario 3: Keep maintenance outsourced
Advantages
- No upfront investment needed.
- Focus on core business: transporting passengers.
Risks/disadvantages
- Service will be likely unsatisfactory again.
- Decrease of revenues and loss of customers as a consequence of bad service and delays caused by poor maintenance.
III. Conclusion
There is no right or wrong answer as long as the decision/recommendation is well founded.
One possible closing for this case could be:
I believe that the BusCo should try to do its maintenance in-house next year. Indeed, it should buy the facilities it will need instead of renting them.
Main reasons
- The benefit analysis showed that investing in the in-house maintenance would respect the firm’s investment payback policy of 4 years.
- Although there is the risk of running a new business operation, we know that nowadays the outsourced service is a very low-quality one.cIt jeopardizes the reputation and customer loyalty of the firm. By running the maintenance in-house, BusCo would be able to set a high quality service standard.
- By buying the facilities instead of renting them, BusCo would have paid back the investment in a very significant real estate asset in as early as 3.5 years. This asset could even increase significantly in value with the real-estate industry seeing a boom in emerging markets (like Uganda).
Difficult Questions
What other options would you consider before taking the decision of keeping the service outsourced with MaintainCo or doing it in-house buying the facilities?
Possible answer:
- All possible contractors with which we could outsource this service should be considered. There may be better maintenance firms than MaintainCo in Uganda.
- Another option would be to start a new maintenance company, under the same direction as BusCo but operationally independent from it (concept of a holding). The company could even provide maintenance for other bus companies than BusCo.
- In order to decrease initial investment costs, it could be a possibility to lease the equipment used for maintenance instead of buying it (which would partially avoid the $2m initial investment).
If the interviewee solves the case very quickly, you can come up with more challenging questions to ask them.
