Chapter 7
Insourcing / Outsourcing
IDIS 424 Spring 2004
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Key Decision
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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:
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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
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Assessing Trends
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What is my relative position?
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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 /
Product
Technology
Manufacturing /
Operations
Procurement
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Outsourcing Candidates - Full
/ Partial
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Products
Technology
 Manufacturing
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Processes
Design Development
 Process Installation
 Equipment Service
 Maintenance
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Outsourcing Candidates Services - Full / Partial
 Work Force - Security,
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Janitorial, Food Service,
etc.
Information Services
Programming
Human Resource
Management
Procurement
Payroll
3rd Party Warehouse
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HMO’s
MRO Inventory
Utilities
Travel Services
Temporary Labor
Outplacement
Copiers / Fax
Customer Satisfaction
services
Fleet services
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Factors Supporting
Outsourcing
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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
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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
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Advantages
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Greater flexibility
Lower investment risk
Improved cash flow
Lower potential labor costs
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Outsourcing
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Disadvantages
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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
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Advantages
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Higher degree of control over inputs
Increases visibility over the process
Economies of scale and scope
Disadvantages
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Requires high volumes
High investment
Dedicated equipment has limited uses
Problems with supply chain integration
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Core Competence
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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
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“...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
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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
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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
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Incremental fixed costs
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Equipment investment
Factory overhead
Managerial costs
Purchasing costs
Inventory carrying costs
Costs of capital & taxes
Special personnel
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Make/Buy Studies
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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
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Be Careful - In-house managers can
easily hide costs!
Traditional analysis only considers
variable costs
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Full Cost Analysis
INSOURCE
Variable Cost
$ 5.00
OUTSOURCE
----------
Variable +
Manufacturing Overhead
$8.00
----------
Variable +
Manufacturing Overhead +
Corporate Overhead
$10.00
$7.50
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Full Cost Analysis
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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
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Variable costs:
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Delivered material cost
Direct labor costs + fringe benefits
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Costs - Outsourcing
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Purchase price of part
Transportation costs
Receiving and inspection
Incremental purchasing cost
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Make or Buy - Other Factors
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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
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Stable and trained workforce
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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
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For specialized equipment, what is the
projected future need for such an
investment?
Forecasted product demand - time and
quantity
Technological considerations
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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
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Supplier goodwill considerations
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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
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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
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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
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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
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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
(depreciation of initial investment)
Employee training
Overhead expenses
Management expenses
Annual capacity
Cost per unit Annual charges
($155,000 / 180,000 units)
Variable costs
Direct labor costs
$25,000
10,000
50,000
70,000
$155,000
180,000 units
$ .86
$1.00
$ .50
$2.36 / unit
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Warehouse Decision
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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
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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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