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Insourcing / OutsourcingIDIS 424 Spring 2004

Chapter 7

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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 COST

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Decision usually arises due to:

New product development, Unsatisfactory supplier / distributor

performance Periods of changing sales patterns

(increasing or decreasing) Expansion of geographic sales

regions

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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?

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Strategy Alignment Through Business Planning

Strategic Business Unit / Product

Manufacturing / Operations

Technology Procurement

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Outsourcing Candidates - Full / Partial

Products Technology Manufacturing

Processes Design 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

HMO’s MRO Inventory Utilities Travel Services Temporary Labor Outplacement Copiers / Fax Customer Satisfaction

services Fleet services

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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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Outsourcing

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

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Outsourcing

Disadvantages Greater possibility of choosing wrong

suppliers/distributors Loss of control over processes Potential for losing “core supportive”

activities Long lead-times “Hollowing out”

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Insourcing Advantages

Higher degree of control over inputs Increases visibility over the process Economies of scale and scope

Disadvantages Requires high volumes High investment Dedicated equipment has limited uses Problems with supply chain integration

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Core Competence

A 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".

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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 Process

Incremental fixed costs Equipment investment Factory overhead Managerial costs Purchasing costs Inventory carrying costs Costs of capital & taxes Special personnel

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Make/Buy Studies Finding True In-house

Costs is not Easy!Costs of OverheadCosts of QualityOperational CostsCapital Costs

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Make/Buy Studies

Be Careful - In-house managers can easily hide costs!

Traditional analysis only considers variable costs

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Full Cost Analysis

INSOURCE OUTSOURCEVariable Cost $ 5.00 ----------

Variable + Manufacturing Overhead $8.00 ----------

Variable +Manufacturing Overhead + Corporate Overhead $10.00 $7.50

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Full Cost Analysis

Issues: 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 Process

Variable costs: Delivered material cost Direct labor costs + fringe benefits

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Costs - Outsourcing

Purchase price of part Transportation costs Receiving and inspection Incremental purchasing cost

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Make or Buy - Other Factors

Availability 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 Factors

Supplier 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

years

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Cost of Private Warehouse

Annual chargesBuilding and equipment $25,000 (depreciation of initial investment)Employee training 10,000Overhead expenses 50,000Management expenses 70,000

$155,000Annual capacity 180,000 units

Cost per unit Annual charges $ .86($155,000 / 180,000 units)Variable costs $1.00Direct labor costs $ .50

$2.36 / unit

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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?

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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