PART 3 CASES Case 3-1: eBay's Outsourcing Strategy.

* Professors Scott Newman, Gary Grikscheit, and Rohit Verma and Research Assistant Vivek Malapati prepared this case solely as the basis for class discussion. The information presented in this case is based on publicly available information and insights gained through numerous interactions between University of Utah MBA students, their faculty advisors, and local eBay managers during a field study project (sponsored by the University of Utah and approved by the eBay Salt Lake City Service Center). The case contains writer-compiled, disguised information and is not intended to endorse and/or illustrate effective or ineffective service management practices. Certain sections of the case study have been fabricated based on current service management and customer service literature to provide a realistic and stimulating classroom experience. The numbers in the case are available from public information or estimates or are fictitious. This case was the winner of the 2006 CIBER-Production and Operations Management Society International Case Competition.

If we are to continue outsourcing, and even consider expanding it, why should we keep paying someone else to do what we can do for ourselves?

Kathy Dalton leaned forward in her chair. She read the message on her computer screen and let the words sink in. Why had she not anticipated that? After all, she was adept at asking insightful questions. She felt her heart rate quicken.

She would have stared out her office window and pondered this question, but she didnt have an office. In keeping with a well-established Silicon Valley tradition, everyone at eBay, including CEO Meg Whitman, occupied a cubicle. Dalton, an attractive, 38-year-old executive, had joined eBay in late 2002 after years of call center experience for major long distance carriers. Now, nearly two years later, she couldnt think of doing business any other way. She liked being in the center of the action. Sitting in a transparent cube, surrounded by hundreds of service representatives, added to her already high level of energy and kept her in touch with eBays internal and external customers.

Dalton reflected on the e-mail she had just received from her boss, Wendy Moss, vice president of Global Customer Support. She knew she would pick up the phone soon, call Moss, and ask her clarifying questions about her e-mail. Her mind raced through the details of the proposed outsourcing strategy she had submitted to Moss last week. She quizzed herself:

• Did my team and I make a strong enough case for proposing almost a 100 percent increase in the amount of volume to be outsourced?

• Will eBay management concur with our recommendation to begin outsourcing potentially sensitive risk-related inquires for the first time?

• How will senior management react to the addition of a second outsourcing vendor?

• Did we cover adequately the types of proposed volumes targeted and how these would be transitioned to the outsourcing vendors?

• In the event of a major vendor problem, systems issue, or natural disaster, how executable is our back-out plan?

• Will the data in our proposal allay the growing concerns among executives about offshore outsourcing altogether?

She wondered, How would eBay senior managers react to our proposal to reorganize and expand outsourcing in a new three-tiered approach? And would they even consider expansion in light of recent headlines about companies reducing the amount of work outsourced to India because of quality issues?

This last question had perplexed her for several months. Not only was it a personal issue for Daltonshe felt her job security at eBay depended largely on the companys continuing commitment to offshore outsourcingbut one she recognized as a business practice whose time perhaps had come and gone. Several leading consultants were claiming that offshoring had lost much of its cachet in recent years as companies were coming to grips with the real costs, logistics, management commitment, and service quality associated with third-party partners in India, the Philippines, and elsewhere. In her proposal, Dalton had reinforced the benefits to eBay of continuing to outsource outside the United States and had woven into her new strategy more nearshoring alternatives as well.

Dalton was scheduled to fly to San Jose in just two weeks to present her outsourcing strategy to Whitman and her executive staff. Now, here was Mosss e-mail, questioning why she had not addressed the option of cutting out the middleman and building eBay-owned outsourcing locations in other countries.

A Little History

eBay called itself The Worlds Online Marketplace. For the sale of goods and services by a diverse community of individuals and small businesses no venue was more appropriate. eBays mission was to provide a robust trading platform where practically anyone could trade practically anything. Sellers included individual collectors of the rare and eclectic, as well as major corporations like Microsoft and IBM. Items sold on eBay ranged from collectibles like trading cards, antiques, dolls, and housewares to everyday items like used cars, clothing, books, CDs, and electronics. With 11 million or more items available on eBay at any one time, it was the largest and most popular person-to-person trading community on the Internet.

eBay came a long way from being a pet project for founder Pierre Omidyar and holding its first auction on Labor Day in September 1995. Omidyar developed a program and launched it on a Web site called Auction Web. According to eBay legend, he was trying to help his wife find other people with whom she could trade Pez dispensers. Omidyar found he was continually adding storage space to handle the amount of e-mail generated, reflecting the pent-up demand for an online meeting place for sellers and buyers. The site soon began to outgrow his personal Internet account.

Realizing the potential this Web service could have, he quit his job as a services development engineer at General Magic, a San Josebased software company, and devoted full-time attention to managing Auction Web. As traffic increased, he also began charging a fee of $0.25 per listing to compensate for the cost involved in maintaining a business Internet account.

In 1996, Jeff Skoll, a Stanford Business School graduate and friend of Omidyars, joined him to further develop Auction Web. They changed the name to eBay, short for East Bay Technologies. In mid-1997, a Menlo Parkbased venture capital firm invested $5 million for a 22 percent stake in eBay. Omidyar knew that the venture capital would be critical in building infrastructure and attracting top-tier management to the company.

In early 1998, Omidyar and Skoll realized eBay needed an experienced CEO to lead and develop an effective management team as well as to solidify the companys financial position with an IPO. In March of that year, Whitman accepted the position of president and CEO. A graduate of the Harvard Business School, Whitman had learned the importance of branding at companies such as Hasbro and Walt Disney. She hired senior staff from companies like Pepsico and Disney. She built a management team with an average of 20 years of business experience per executive and developed a strong vision for the company. Whitman immediately understood that the eBay community of users was the foundation of the companys business model. A central tenant of eBays culture was captured in the phrase The community was not built for eBay, but eBay was built by and for the community. It was not about just selling things on the Internet; it was about bonding people through the Web site.

Business Model and Market Share

Unlike many companies that were born before the Internet and then had to scramble to get online, eBay was born with the Net. Its transaction-based business model was perfectly suited for the Internet. Sellers listed items for sale on the Web site. Interested buyers could either bid higher than the previous bid in an auction format or use the Buy It Now feature and pay a predetermined price. The seller and buyer worked out the shipping method. Payment was usually made through PayPal, the worlds leading online payment company, which eBay acquired in 2002. Because eBay never handled the items being sold, it did not incur warehousing expense and, of course, did not hold any inventory. For a company with almost $8 billion in assets, not a single dollar was invested in inventory (Exhibit 1).

In 2004, eBay reported revenue of nearly $3.3 billion. Revenue was mainly generated from two categories. The first, called the Listing Fee, involved a nominal fee incurred by the seller in posting an item for sale. This fee ranged from $0.25 to $2.00. The second, the Final Value Fee, was charged to the seller as a percentage of the final price when a sale was made. This amounted to between 1.25 percent and 5 percent of the selling price, depending on the price of the item. The Final Value Fee on a $4.00 Beanie Baby would be $0.20, representing a 5 percent fee. The same fee on a mainframe computer selling for $400,000.00 would be 1.25 percent, or $5,000.00.

eBays Income Statement (in 000s Dollars)	12/31/2004	12/31/2003	12/31/2002
Net revenues	$ 3,271,309	$ 2,165,096	$ 1,214,100
Cost of net revenues	614,415	416,058	213,876
Gross profit (loss)	2,656,894	1,749,038	1,000,224
Sales and marketing expenses	857,874	567,565	349,650
Product development expenses	240,647	159,315	104,636
General and administrative expenses	415,725	302,703	171,785
Patent litigation expense		29,965
Payroll expense on employee stock options	17,479	9,590	4,015
Amortization of acquired intangible assets	65,927	50,659	15,941
Total operating expenses	1,597,652	1,119,797	646,027
Income (loss) from operations	1,059,242	629,241	354,197
Interest and other income, net	77,867	37,803	49,209
Interest expense	8,879	4,314	1,492
Impairment of certain equity investments		-1,230	-3,781
Income before income taxUnited States	820,892
Income before Income taxinternational	307,338
Net income (loss)	778,223	441,771	249,891
Net income (loss) per share-diluted	0.57	0.335	0.213
Net income (loss)	778,223	441,771	249,891
Cumulative effect of accounting change		5,413
Provision for doubtful accounts and auth cred	90,942	46,049	25,455
Provision for transaction losses	50,459	36,401	7,832
Depreciation and amortization	253,690	159,003	76,576
Stock-based compensation		5,492	5,953
Amortization of unearned stock-based compens	5,832
Tax benefit on the exer of employ stock opts	261,983	130,638	91,237
Impairment of certain equity investments		1,230	3,781
Minority interests	6,122
Minority interest and other net income adj		7,784	1,324
Gain (loss) on sale of assets			-21,378
Accounts receivable	-105,540	-153,373	-54,583
Funds receivable from customers	-44,751	-38,879	-11,819
Other current assets	-312,756	-13,133	10,716
Other non-current assets	-308	-4,111	-1,195
Deferred tax assets, net		69,770	8,134
Deferred tax liabilities, net	28,652
Accounts payable	-33,975	17,348	14,631
Net cash flows from investing activities	-2,013,220	-1,319,542	-157,759
Proceeds from issuance of common stock, net	650,638	700,817	252,181
Proceeds (principal pmts) on long-term obligs	-2,969	-11,951	-64
Partnership distributions			-50
Net cash flows from financing activities	647,669	688,866	252,067
Eff of exch rate change on cash and cash equivs	28,768	28,757	11,133
Net incr (decr) in cash and cash equivalents	-51,468	272,200	585,344
Cash and cash equivalents, beginning of year	1,381,513	1,109,313	523,969
Cash and cash equivalents, end of year	1,330,045	1,381,513	1,109,313
Cash paid for interest	8,234	3,237	1,492

Exhibit 1 Income Statement and Balance Sheet (abridged)

Source: Case writers estimates, compilations, and public records.

Being first to market in the e-commerce world was frequently an insurmountable competitive edge. eBay capitalized on being the first online auction house. Early competition came from companies like OnSale, Auction Universe, Amazon, Yahoo!, and Classified2000. These companies battled eBay on a number of fronts, mainly pricing, advertising online, and attempting to lure key eBay employees away to join their ranks. eBays biggest and most formidable competitive threat came from Amazon.com when it spent more than $12 million launching its person-to-person auction service in 1999. eBay withstood all of these challenges. Amazons efforts ultimately failed because it could not

What are you (acting as Kathy Dalton) going to present at the outsourcing strategy meeting in two weeks, and why? As companies like Dell are reducing some outsourcing, why should eBay consider expanding outsourcing; or, why shouldn't they? What are the limits of trust and safety when it comes to outsourcing? What are some of the advantages and disadvantages of the BOT strategy; and, how do these stack up against the other two options Ms. Dalton outlines in her spreadsheet? Finally, what are the strategic implications of opportunism, capability, and flexibility for Ms. Dalton's options? What do you predict eBay's senior management will do with Kathy Dalton's new three-tiered outsourcing strategy