August 1999
PM217 : PROJECT MANAGEMENT

QUESTION 4

Total Marks: 20 Marks

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(a) Describe what is meant by "outsourcing" some aspect of a business. [2]
There are many ways of explaining this term, but one would be that outsourcing is the use of external specialists to carry out some aspect of an organization's business.
(b) Based on your understanding of outsourcing, explain three possible reasons or scenarios in some detail that could cause an organization to use outsourcing. [6]
  • General tendency for an organization to specialize in one particular area as compared to a generalization of skills;
  • A specialized contractor can frequently do the job more effectively and cheaply;
  • The enormous cost-savings made as the organization does not need to pay for work benefits such as insurance, bonuses etc.;
  • An outsourcing contractor often provides world-class expertise in their specialized areas.
(c) Two possible types of contracts in outsourcing are : fixed-price contracts and cost-plus contracts. Describe clearly each of these types of contracts. [2]
Fixed-price contract:  both organization and outsourcing contractor agree that the deliverables will be produced for an agree-upon price.

Cost-plus contract: where the organization will agree to reimburse outsourcing contractors for costs incurred.
(d) For each type of contract, does the risk lie with the organization or with the outsourcing contractor? Justify your explanation. [4]
Fixed-price contracts: risk lies with the outsourcing contractor, since the amount of funds payable is fixed throughout the contract, and the contractor has to ensure that his own costs of development are covered by the funds provided, and that a profit can still be made.

Cost-plus contracts: risk likes with the organization, since the outsourcing contractor's knows that all costs will be re-imbursed, on top of which a fee will be paid.
(e) Identify and briefly describe the three possible types of cost-plus contracts. [6]
Cost-plus-fixed-fee(CPFF) contract: removes incentives for excessive spending by limiting the contractor's profit to a fixed amount, regardless of project costs;

Cost-plus-incentive-fee(CPIF) contract: provides incentives and disincentives to encourage cost-effective project performance.

Cost-plus-award-fee(CPAF) contract: incentives and disincentives are determined formulas.