Outsourcing decisions: yes or no?

In the comparison below, two companies in similar markets offer competing products. On the left is a company performing activities in-house. At right is a competing company that outsources its none-core competencies. Variable costs (VC) and revenues (R) are equivalent for both organizations.

The competing company at right does not have the overhead operating costs associated with performing activities in-house. Therefore, the competing company also has lower fixed costs (FC) and an overall lower total cost (TC) of doing business, where:

VC + FC = TC

Whether in the United States, India, China, or some other geography, in most instances, companies that offshore or outsource achieve a greater return on invested capital; greater return on equity, and greater return on assets than companies that do not outsource. Manufacturing companies that use outsourcing services also reach break even (BE) sooner, where profits begin, against less revenues and lower volume.

Unfortunately, many OEMs do not engage a contract manufacturing partner early enough. OEM executives considering outsourcing should take a core competency litmus test consisting of three questions:

If starting from scratch today, would we build capability inside?
Are we so good others would pay us to do it?
Is this an area of our business from which future leaders will come?

If an executive answers yes to one of these question, there’s a good chance he or she may not want to outsource -- for strategic reasons. Otherwise, it usually makes sense to outsource and engage the contract manufacturer as soon as possible.

The earlier the contract manufacturer is brought into the decision-making process, the sooner he can provide insight into design-for-manufacturing (DFM) requirements based on his years of experience and incorporate this knowledge into the OEM’s product to help minimize costly OEM design iterations that may otherwise disrupt the OEM’s time-to-market (TTM) strategy and, ultimately, could result in loss of market share in some instances.

In spite of all of this, many executives are still reluctant to embrace contract manufacturing. One obstacle has been executives are often required to assign value to business units—including outsourced functions—according to the contribution to their company's bottom line.

The difficulty of properly deciding how these functions affect the value of a company's fixed assets can sometimes prevent original equipment manufacturing executives from acknowledging the comparative value of outsourcing manufacturing or design activities.

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