Question

A company is deciding if it should design a product in-house or outsource the design. If outsourced, the cost for a low bidder would be $40,000, and the cost for an expensive bidder would be $100,000. To design in-house would require overtime for an already stretched design team with total costs of $70,000. If all three designs (in-house, low bid, high bid) are equal in quality and the likelihood of finding a low bidder is 60% (meaning that 40% of the time the firm will have to hire the expensive bidder), should the company outsource design or do it in-house?

*can you please text the ansumer not picture :)

Answer 1

There are 2 choices in front of the company - In-House or Outsource.

If it goes for In-house, costs to company = $70k

If it goes for outsourcing, there would be 2 possibilities:

1. It finds a low bidder of $40k. Probability of this happening = 60%. So, Expected cost to company = $40k * 0.60 = $24k

2. It finds a high bidder of $100k. Probability of this happening = 40%. So, Expected cost to company = $100k * 0.40 = $40k

So, net expected cost to company if case of outsourcing = 24 + 40 = $64k.

Now, in-housing costs $70k and outsourcing costs an expected value of $64k to the company. Company should go for lower cost option, i.e., Outsourcing.