Chapter 7

Insourcing / Outsourcing
IDIS 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 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 2. Assess Strategic

Technology and Alignment and Core
Demand Trends Competencies

3. Conduct Total Cost 4. Consider the “Big

Analysis of Picture” and Reach
Insourcing/Outsourcing Decision
Alternatives

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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 / Manufacturing /

Product 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,  HMO’s

Janitorial, Food Service,  MRO Inventory
etc.  Utilities
 Information Services  Travel Services
 Programming  Temporary Labor
 Human Resource  Outplacement
Management
 Copiers / Fax
 Procurement
 Customer Satisfaction
 Payroll
services
 3rd Party Warehouse  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 Overhead
 Costs of Quality
 Operational Costs
 Capital 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 OUTSOURCE
Variable 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 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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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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