Insourcing / Outsourcing IDIS 424 Spring 2004

1. Insourcing / OutsourcingIDIS 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 • Products • Technology • Manufacturing • Processes • Design Development • Process Installation • Equipment Service • 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 $ 5.00 ---------- Variable + Manufacturing Overhead $8.00 ---------- 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