Uncommon Sense: Does Outsourcing Cut Costs?
The trend in outsourcing operations so that companies can, allegedly, focus on their core competencies and reduce costs has gone so far that the dictionary definition includes the basic assumption of lower cost:
"Outsourcing: the procurement of services and products, such as parts used in manufacturing a motor vehicle, from an outside supplier or manufacturer in order to cut costs,"
Companies typically consider their core competencies to be research and development, sales and-only sometimes-final assembly of their products. In Build-to-Order & Mass Customization (CIM Press, Cambria, CA) Dr. David Anderson, P.E., CMC, notes that companies typically try to focus on what they are "good at" and outsource the rest.
Although this seems logical on the surface, Anderson says "This cart-before-the-horse strategy results in the corporate business model being determined by a collection of ‘whatever everyone happens to be good at' at the time." He believes that it would be better for the business model to decide the set of core competencies that need to be developed to support the business model.
In deciding whether or not to outsource an operation, it is important to consider its true total cost. Unfortunately, the cost accounting systems most companies use are so inadequate that they actually hinder the ability to make good management decisions. Labor and materials, the focus of most outsourcing decisions, are actually a small part of the true total cost.
True total cost includes cost elements such as inventory, setup, changeover, material, customization, quality, product development, equipment, tooling and distribution. All of these are overhead costs, which are generally increasing because of market pressures and perceived opportunities in the marketplace.
Traditional cost accounting systems present the financial position of the organization for the benefit of investors and agencies that tax or regulate. They can, however, distort product costing and they typically fail to account for cross subsidies.
Based on traditional cost accounting methods, many companies are moving manufacturing operations overseas or to foreign countries because they think it will reduce costs. Their cost systems actually justify such moves in most cases because, if all they quantify is parts and labor, moving to a low labor rate area will indeed make it appear that the move will reduce costs.
In fact, however, overseas manufacturing rarely yields net cost savings because:
• Reduced labor efficiency can cancel out labor rate savings.
• Labor-intensive designs can reduce or even cancel out labor savings.
• Training costs can exceed projections.
• Quality costs can actually increase.
• Insufficient capacity can add costs.
• Equipment utilization can drop way below optimum levels.
• Automation is hard to justify.
• Cheap labor doesn't stay that way.
• Start-up costs can be underestimated.
• Travel and communication costs typically increase.
So a word to the wise-don't assume that you will cut your costs by sending operations overseas. All of the excess costs will be known by the time production has been moved. But by then it may be too late to make up for the competitive disadvantages that you may encounter, namely:
• Longer product delivery times.
• Decreased supplier responsiveness.
• Supply vulnerabilities.
• Lack of design competitiveness.
• Loss of manufacturing control.
• Communications difficulties.
• Liability risks.
• Interference with other improvement programs.
Any or all of these may cause additional hidden costs that make the decision to outsource a wrong one.