In times of changing competitive pressure, shorter product life cycles and increasing globalization, companies must react flexibly and cost-effectively to changing market conditions. Many companies ask themselves the question: Should we produce by ourselves or should we outsource production? The decision is made according to criteria such as costs, quality, time, availability of resources and risks. For this reason, a strategic in-house production/external procurement analysis is absolutely necessary in order to weigh up all the advantages and disadvantages if you want to concentrate on your core competencies.
Example automotive industry
The product range of automobile manufacturers has grown strongly in recent years. As a result, production complexity has increased. In order to meet this challenge, manufacturers are purchasing more and more parts from external manufacturers. The share of in-house production fell by 12% between 1985 and 2000 and a further 5% between 2000 and 2005. Experts estimate that the share of in-house production in the total product will only amount to 25% in 2015. Automobile manufacturers like Smart have even reduced their share of in-house production to around 10%.
As a result of external procurement, suppliers are increasingly assuming a central position in the development and production of automobiles. Manufacturers basically only assemble the supplied parts.
Outsourcing can strengthen your own innovation dynamic
The reason why outsourcing decisions have increased, for example in the automotive industry, is not only the cost factor but also the expansion of innovation dynamics. A supplier of certain parts required for an end product, for example, may be much more specialized and thus have a higher innovative strength. It is therefore important to identify potential cooperation partners in all direct and indirect areas of operational value creation in order to profit from this innovation dynamic and streamline one’s own value creation process on the other hand. The goal of strategic make or buy decisions is to turn the supplier into a system provider and integrate him into the value chain as a long-term partner. Short-term, operative make-or-buy decisions, however, usually serve to cover demand peaks.
Outsourcing to streamline value creation
By outsourcing internal services or entire production processes, the company can concentrate on its core competencies and reduce costs sustainably. Here, contracts with suppliers should be negotiated in such a way that in-house production and external procurement are optimally synchronized. For example, strategic solutions must be developed with the supplier in conjunction with just-in-time concepts. In order to optimize throughput times and reduce inventories of delivered parts, it is also possible to set up a consignment warehouse and completely transfer the logistics for this to the system partners.
Total cost analysis
If you want to optimize vertical integration through outsourcing, you have to map and compare the costs of all resources and processes that are affected by outsourcing. Based on a detailed supplier evaluation, the concrete procurement objects must be calculated. This also includes the additional costs incurred as a result of the transition to external procurement. Particularly during this transition period, it is possible that the production processes cannot be reduced, outsourced and overlay each other at the same time, resulting in short-term additional costs. In addition, there are, for example, the costs for the shutdown of machines resulting from the buy decision. However, for plants that are sold above the book value, an extraordinary return can also be achieved with the right preparation.
Clarify responsibilities contractually
Many suppliers bear full responsibility for their products, from design to measurement of final customer satisfaction. For example, a manufacturer may hire a supplier to outsource production: The supplier contractually undertakes to comply with specifications and regulations for the product to be manufactured by the customer’s engineers. This audit requirement must be met by the supplier without deviation. The obligations of a third-party manufacturer include verifiable testing of the requested product and continuous quality measurement of the development of the part over a specified period of time. Further tasks of the suppliers are the packing and stowing of the goods as well as the organization of transport and the regulation of the shipping process. In addition, the partner must ensure a smooth supply in order to be able to maintain the processes at the customer. Security of supply must be ensured by contract through prefabrication and delivery concepts.
In-house production offers protection for company secrets and know-how. Self-manufactured parts can be flexibly adapted to production processes. Production in the company’s own facilities reduces logistics costs, shortens communication channels and reduces coordination effort. In-house production can be an experience and learning option for companies. Ultimately, the company is independent of suppliers and protected from image damage by third-party manufacturers.
The acquisition and maintenance of production plants and machines is a cost-intensive process for companies. In addition, it requires specialized knowledge to manufacture certain components in appropriate quality.
The purchase of externally manufactured components reduces the production depth of the company, so that the focus remains on the actual core business. The elimination of acquisition, maintenance and energy costs for production plants and machines makes it possible to reduce fixed costs. A just-in-time system can save storage costs. Further costs can be reduced if the supplier performs its own research and development. There are highly specialized suppliers who have a certain know-how in their field and thus offer the best quality. In addition, tax advantages can arise through external procurement and risks can be transferred to several suppliers. In addition, trained employees can be deployed in other areas so that no know-how is lost.
External processing leads to increased dependence on the supplier. If the supplier gets into economic problems or qualitative deficits occur, follow-up costs can arise and production would probably be endangered. In addition, a supplier could compete with the company’s own employees and replace their jobs. This could lead to internal employee resistance in the event of loss of employment. A further disadvantage is that the supplier gains insight into sensitive company data.