Maybe you never considered how outsourcing manufacturing versus making the product in-house impacts your marketing. Well, the make versus buy decision is more than a simple financial calculation as aspects of the product critical to your customers are bound up in this decision.
On the positive, companies that outsource intelligently often wind up making a better return on their investment, enjoy lower costs, and can deliver a superior customer experience.
On the negative side, firms who outsource manufacturing face challenges including:
- Long supply chains
- Poor quality
- Lack of control
- Poor customer perceptions
The question of outsourcing overseas is a tough one politically as more governments and consumers embrace waves of nationalism that questions the value of globalization. But economists taught us for years that all countries are better off when each specializes in a particular form of trade. Ever since the days of David Ricardo, we’ve known that internationalizing the economy (something economists term international comparative advantage) makes things better for everyone overall by allowing each county to rely on its own factor endowments to reduce costs.
Calculating the value of outsourcing manufacturing is complex, involving both financial considerations as well as operational and marketing opportunities. In today’s post, we’ll discuss some advantages to consider in your own outsourcing evaluation.
Advantages of outsourcing manufacturing
Outsourcing manufacturing reduces your risk when introducing a new product or starting a new business because the costs of setting up manufacturing operations are massive and result in large, ongoing fixed costs. If your product flops, you’ve lost most of the money invested in property, plant, and equipment.
Meanwhile, outsourcing requires very little expenditure on fixed operations, thus reducing your risks since you can shift easily to another product with only a possible penalty for canceling your contract.
In the long run, however, making your own products in-house is often a better option as your profit per product is higher than when outsourcing manufacturing since you eliminate the profit earned by the third-party manufacturer.
We often overlook the fact that outsourcing production to a foreign country is a relatively straightforward process. It’s certainly much more manageable than setting up a factory domestically. On the face of it, it seems complicated. But when you actually get down to the process itself, it’s more like ordering goods off a shelf, instead of developing complex systems yourself.
Remember, many of these manufacturing operations already have facilities in place to manufacture products. What’s more, many also have robust supply networks that allow them to source any secondary goods that they need for assembly. For the most part, it is a well-oiled machine.
Contract manufacturers, often located overseas, offer facilities they can reconfigure to manufacture a wide range of products to maximize flexibility and serve a number of different types of products.
Even if you want to do things like send money to China or engage in other international financial arrangements, the process is easy. Modern payment systems mean that you don’t have to deal with the traditional banking system. And that can free things up tremendously.
Closeness to resources
Think about how difficult it is to get parts sometimes in the country in which you operate. It can be a nightmare. Often, there are no domestic producers at all, and you wind up having to import raw materials or subassemblies from overseas – dealing with complex quotas and duties in the process.
Smart companies, though, know that this closeness to resources is a significant business advantage. And that’s yet another reason why they go to overseas companies for their production needs. Local manufacturers are often much closer to natural resources and the secondary parts that they need for assembly. Furthermore, these supplier relationships are often much better established than they are in Western markets. That means that if you want to change some aspect of your product – like upgrade the electronics – you can do it quickly.
For example, bauxite is the main material used in the production of aluminum. The ore, which is heavy, which involves high shipping costs, comes from several countries, with the largest deposits in Australia. A company might locate its facilities near one of these major bauxite deposits to produce aluminum foil or aluminum car parts more efficiently.
There are reasons companies historically left Western countries (especially e-commerce) and set up production in other parts of the world: overhead costs.
The sheer cost of creating a manufacturing facility from scratch in wealthy countries is often prohibitive. The sheer cost to buy land, to build, and to obtain needed machinery in Western countries is high. Not to mention the ongoing costs for taxes, insurance, utilities, and government compliance add millions to your overhead.
When your production is outsourced overseas, though, these costs fall enormously. The overall savings mean you compete on price with your rivals and secure bigger margins.
Smaller labor costs
It’s worth reiterating the sheer difference in labor costs when you outsource production to countries like Mexico, Indonesia, China, and other parts of East Asia. According to data from the Huffington Post, manufacturing plant workers’ wages in these regions are ten times lower than in the US.
What’s so remarkable about this setup, though, is how everyone wins. Most workers in these countries earn dramatically higher wages working in these international facilities than alternative employment opportunities.
Not only do individuals benefit from higher incomes but society benefits through the transfer of knowledge, know-how, and other intangibles from high-wage countries to low-wage countries. Because new manufacturing facilities often involve building new roads, power stations, and ancillary facilities to service the plant, international partners gain needed resources. On an international scale, these factors improve economic and political stability, decreasing the chances of international or domestic conflict.
Focus on core operations
Finally, there’s the benefit that you’re able to focus on your core operations when you outsource. You no longer have to worry about the technicalities of how you’ll actually produce the goods – that’s something that another firm takes care of as part of their core operations.
This statement might sound a little strange. After all, aren’t companies supposed to produce their own goods? The problem is that many of the tasks that go into an effective production operation take time to develop. Companies can’t just waltz into production and expect everything to go according to plan. That’s not how it works. Usually, these operations require vast investment in time, energy, and money, which may not offer a positive return when compared with outsourcing manufacturing.
When you take this burden away from your enterprise, you’re able to focus more on product development and strategy – the things that are really going to add value to what you’re doing.
Negative aspects of outsourcing manufacturing
Obviously, outsourcing manufacturing isn’t a total win in every scenario, as some negative aspects of outsourcing might make it a bad decision. We mentioned some of these negatives earlier, but let’s return to them now in more detail.
Long supply chains
The cheaper countries in terms of labor costs are often also farther away, like China. This distance means it takes time for products to transport products half a world away to Western Europe and the US. Long transportation not only increases costs but involves long delays in the product reaching consumer markets. For instance, a fashion house used Chinese apparel businesses to sew garments, which required retailers in the US and Western Europe to order products well before the season. Once the season shopping began, products in high demand couldn’t reach retailers in time for them to restock to satisfy that demand, resulting in high opportunity costs for the fashion house.
Products manufactured overseas might not meet Western demands in terms of quality or may simply suffer from poor perceptions of quality. For instance, I interviewed a company located along the Mexican border in Texas. They brought back their manufacturing operations from Mexico because workers there underperformed their US counterparts even after gaining substantial experience.
Lack of control
One of the biggest headaches when outsourcing manufacturing is the inherent lack of control. Sure, your supplier has a contractual obligation to produce products that meet your specifications on the timetable specified in the agreement, but a breach of contract means a contracted legal battle that doesn’t meet your current needs; leaving you in the lurch.
Further, if you want to change your product, another long, protracted negotiation is necessary, slowing down your ability to innovate and reducing nimbleness.
We alluded to this earlier. Consumers suffer biases regarding the appropriateness of certain countries for producing certain goods. For instance, we love Swiss watches and chocolate but don’t have the same opinion of their other products. In the US, we generally view Chinese products as poor quality while loving Japanese technology. BTW, Japanese products were once viewed as poor quality. For instance, in the early days of Toyota, no one wanted their cars. But, years of focus on quality and fast innovation transformed Toyota into one of the most admired automobile manufacturers.
Decisions about outsourcing manufacturing are serious, with long-term implications for the success or failure of your business. Consider the factors mentioned in this post to guide decision-making.
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