Management of outsourced

operations
Outsourcing Vs Insourcing
Outsourcing
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

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
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?

Strategy Alignment Through Business
Planning
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Strategic Business Unit /
Product
Manufacturing /
Operations
Technology
Procurement
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
Desire not to add workforce
Uncertain volume requirements
Routine item available from many sources
Building requires high capital startup costs

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

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
Lack of reliable suppliers
Stable workforce w/ declining volumes
Technical items related to core competence
Strategic item or technology behind
Costs - Insourcing Process
Incremental fixed costs
Equipment investment
Factory overhead
Managerial costs
Purchasing costs
Inventory carrying costs
Costs of capital & taxes
Special personnel
Make/Buy Studies
Finding True In-house Costs is not Easy!
Costs of Overhead
Costs of Quality
Operational Costs
Capital Costs
Be Careful - In-house managers can easily hide
costs!
Traditional analysis only considers variable
costs

Full Cost Analysis
INSOURCE OUTSOURCE
Variable Cost $ 5.00 ----------

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

Variable +
Manufacturing Overhead +
Corporate Overhead $10.00 $7.50

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?

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
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

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?
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

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?

Assignment: 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 charges
Building and equipment $25,000
(depreciation of initial investment)
Employee training 10,000
Overhead expenses 50,000
Management expenses 70,000
$155,000
Annual capacity 180,000 units

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