In Sourcing vs Outsourcing

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Transcript of In Sourcing vs Outsourcing

Chapter 7 Insourcing / OutsourcingIDIS 424 Spring 2004

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Key Decision

Purchasing an item, process, or service externally when the organization has the capability to produce it internally is equivalent to "selling jobs" Overriding factor in considering internal versus external products/processes / services is TOTAL COST2

Decision usually arises due to:

New product development, Unsatisfactory supplier / distributor performance Periods of changing sales patterns (increasing or decreasing) Expansion of geographic sales regions3

Decision Process

1. Assess Technology and Demand Trends

2. Assess Strategic Alignment and Core Competencies

3. Conduct Total Cost Analysis of Insourcing/Outsourcing Alternatives

4. Consider the Big Picture and Reach Decision

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Assessing Trends

What is my relative position? Cost Quality Delivery / Responsiveness Technology Cycle times

Is this considered a core/critical current or future competency? If behind, can we catch-up / surpass?5

Strategy Alignment Through Business PlanningStrategic Business Unit / Product Manufacturing / Operations

Technology

Procurement

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Outsourcing Candidates - Full / Partial

ProductsTechnology Manufacturing

ProcessesDesign Development Process Installation Equipment Service Maintenance

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Outsourcing Candidates Services - Full / Partial Work Force - Security,

Janitorial, Food Service, etc. Information Services Programming Human Resource Management Procurement Payroll 3rd Party Warehouse

HMOs MRO Inventory Utilities Travel Services Temporary Labor Outplacement Copiers / Fax Customer Satisfaction services Fleet services8

Factors Supporting Outsourcing

Supplier has specialized know-how Cost considerations favor supplier Firm lacks ability to build item Small volume requirements Firm's capacity constraints

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Factors Supporting Outsourcing

Desire not to add workforce Uncertain volume requirements Routine item available from many sources Building requires high capital startup costs

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OutsourcingAdvantages

Greater flexibility Lower investment risk Improved cash flow Lower potential labor costs

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OutsourcingDisadvantages

Greater possibility of choosing wrong suppliers/distributors Loss of control over processes Potential for losing core supportive activities Long lead-times Hollowing out12

Insourcing

Advantages

Higher degree of control over inputs Increases visibility over the process Economies of scale and scope Requires high volumes High investment Dedicated equipment has limited uses Problems with supply chain integration

Disadvantages

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Core CompetenceA firm's long run, strategic ability to build a dominant set of technologies and/or skills which enable the firm to adapt to quickly changing marketplace opportunities. A skill, process, or resource that distinguishes a company and makes them "stand out from the rest".14

Core Competence...the collective learning in the organization, especially how to coordinate diverse production skills and integrate multiple streams of technologies. (Prahalad and Hamel 1994)

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Factors Supporting Insourcing

Favorable cost considerations Desire to integrate operations Use available capacity to absorb fixed overhead Control over production and quality Design secrecy required

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Factors Supporting Insourcing

Lack of reliable suppliers Stable workforce w/ declining volumes Technical items related to core competence Strategic item or technology behind

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Costs - Insourcing ProcessIncremental fixed costs

Equipment investment Factory overhead Managerial costs Purchasing costs Inventory carrying costs Costs of capital & taxes Special personnel18

Make/Buy Studies

Finding True In-house Costs is not Easy! Costs of Overhead Costs of Quality Operational Costs Capital Costs

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Make/Buy StudiesBe Careful - In-house managers can easily hide costs! Traditional analysis only considers variable costs

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Full Cost AnalysisINSOURCE Variable Cost Variable + Manufacturing Overhead Variable + Manufacturing Overhead + Corporate Overhead $ 5.00 OUTSOURCE ----------

$8.00

----------

$10.00

$7.50

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Full Cost AnalysisIssues: What costs stay and which go - validity? Opportunity for actual improvement Impact of other considerations (Quality, Delivery Reliability, Technology, etc.) What are the longer-term strategic implications?

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Costs - Insourcing ProcessVariable costs:

Delivered material cost Direct labor costs + fringe benefits

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Costs - OutsourcingPurchase price of part Transportation costs Receiving and inspection Incremental purchasing cost

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Make or Buy - Other FactorsAvailability of current capacity and projected workload during life cycle of item Extremely tight quality specifications may favor in-house operations

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Make or Buy - Other Factors

Stable and trained workforce

Need for expansion may make them unavailable Recruitment and training of an additional work force may result in an unstable condition Tight labor markets Union contracts may present inflexible situations Conservative forecasts will benefit suppliers or result in excessive idle time

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Make or Buy - Other Factors

For specialized equipment, what is the projected future need for such an investment? Forecasted product demand - time and quantity Technological considerations

Complex technical products Suppliers with specialized knowledge or patents Factory "focus" - what business are we in?

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Make or Buy - Other FactorsSupplier goodwill considerations

Using suppliers only occasionally as buffers may result in loss of goodwill and long term damage

Avoiding proprietary data leaks Capital outlay and associated risks

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Questions to Consider Insourcing Costs

What effect will insourcing a purchased product/process/service have on the cost structure of this and other processes carried out in-house?

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Discussion Problem: Warehouse Decision

Manufacturer is considering performing warehouse function internally Has recently reduced its manufacturing workforce by thirty full-time hourly employees and three managers

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Make or Buy: Warehouse Decision

Warehouse sales reps contact a public warehouse electronically, where warehouse personnel pick and pack the order and arrange the shipment Initial benefit = decrease in per unit warehouse charges from $2.90 to $2.36 in a private warehouse

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Make or Buy: Warehouse Decision

Reduced labor force (jobs for laid-off workers, with additional cost training) Sales personnel could have offices in the warehouse Greater control over operations Assume warehouse operates for ten years32

Cost of Private WarehouseAnnual charges Building and equipment (depreciation of initial investment) Employee training Overhead expenses Management expenses Annual capacity Cost per unit Annual charges ($155,000 / 180,000 units) Variable costs Direct labor costs $25,000 10,000 50,000 70,000 $155,000 180,000 units $ .86 $1.00 $ .50 $2.36 / unit33

Warehouse Decision

List all of the advantages of insourcing the warehouse List all of the advantages of outsourcing the warehouse What would be your final decision, taking into consideration of these considerations?34

Summary

The insourcing/outsourcing decision requires a careful understanding of internal core competencies, both currently and in the future The decision involves considering total cost, as well as quality, technology, and customer requirements Insourcing/outsourcing decisions must be aligned with other functional strategies

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