1 Insourcing / Outsourcing IDIS 424 Spring 2004 Chapter 7

2 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

3 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

4 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

5 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?

6 Strategy Alignment Through Business Planning Strategic Business Unit / Product Manufacturing / Operations Technology Procurement

7 Outsourcing Candidates - Full / Partial n Products l Technology l Manufacturing n Processes l Design Development l Process Installation l Equipment Service l Maintenance

8 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

9 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

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

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

12 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”

13 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

14 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".

15 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)

16 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

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

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

19 Make/Buy Studies Finding True In-house Costs is not Easy! Costs of Overhead Costs of Quality Operational Costs Capital Costs

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

21 Full Cost Analysis INSOURCE OUTSOURCE Variable Cost $ Variable + Manufacturing Overhead $ Variable + Manufacturing Overhead + Corporate Overhead $10.00$7.50

22 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?

23 Costs - Insourcing Process Variable costs: Delivered material cost Direct labor costs + fringe benefits

24 Costs - Outsourcing Purchase price of part Transportation costs Receiving and inspection Incremental purchasing cost

25 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

26 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

27 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?

28 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

29 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?

30 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

31 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

32 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

33 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

34 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?

35 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