Galaxy Micro Systems

Abstract

Galaxy Micro Systems is negotiating with a vendor about the cost of service support for the warranty on Galaxy's new workstation. The vendor has offered Galaxy a choice between a fixed-price, lump-sum contract and a deferred-payment scheme based on the number of units installed. Uncertainty in the sales forecast complicates the choice. All uncertainties are expressed in terms of discrete probabilities. Excerpt UVA-QA-0394 GALAXY MICRO SYSTEMS For the past three months, Taylor Jansen of Galaxy Micro Systems had been discussing with a national computer sales-and-service franchiser the subcontracting of the warranty contract for the new Galaxy workstation, the GMS-II. In addition to featuring an advanced technology chip and a state-of-the-art processor, the GMS-II would be sold with a three-year warranty that included parts and labor. Galaxy had decided to subcontract the service support for the warranty rather than to expand its regional offices to include a technical support staff. As the GMS-II project manager, Jansen had moved contract discussions to the point where the specification of the terms and conditions of the warranty contract were acceptable to both parties, but the pricing of the contract was undecided. At a recent meeting, the franchiser's negotiating team had proposed to Galaxy the choice of two pricing schemes for the warranty of those units installed during the introductory year. The first approach was a fixed price contract with a lump sum payment of $ 770,000 due on May 1, 1993, the planned date for the introduction of the GMS-II. Alternatively, the price could be a function of the number of units installed during the introductory year, and payments would be spread over three years. The specific terms would be $ 70,000 payable on May 1, 1993, plus three annual installments of $ 80 per unit for those units installed during the introductory year, May 1, 1993, to April 30, 1994. The annual installments were subject to a minimum of $ 250,000 and were payable on the first of May of 1994, 1995, and 1996. For either alternative, a new contract would be negotiated for sales occurring after the introductory year. For the services rendered by the franchiser, both proposals seemed reasonable to Jansen and compatible with the negotiating limits specified by Galaxy's senior management. The choice between the alternatives, however, was difficult. The deferred-payment schedule of the installment contract was a real advantage in light of Galaxy's hurdle rate of 18%. Offsetting that advantage, however, was the sense that the installment contract was riskier than the fixed price contract because first-year sales of the GMS-II were uncertain. During the introductory year, GMS-II sales would come from two sources: (1) the successful closure by senior management of an extraordinarily large purchase by a single customer, and (2) the efforts of the Galaxy regional offices. Unfortunately, Jansen was uncertain about the results of both sources. . . .