Monday, May 17, 2010

The "Make or Buy" decision

The first thing that needs to be done is to define, “What is Outsourcing”? Outsourcing is the procurement of products or services outside of ones own company. With that out of the way the discussion as to “why outsource” can be engaged with clear understanding. Whether or not to outsource is simply the make or buy decision, and that decision is based upon several factors. The first and I think the most important question that must be asked is does this particular activity fall within the company’s core competency? If it does not then it is a candidate for outsourcing. There are those people who feel that they are betraying their employees by outsourcing any part of manufacturing, but companies outsource many functions every day and think little of it. Most companies outsource their payroll tasks, security, janitorial and cleaning along with other functions too numerous to mention here, and they do it for the one simple reason that it’s more cost effective to let pay someone else to do it. This is most commonly referred to as “Economy of Scale”, simply put its easier and cheaper to let a payroll company manage payroll than to hire a person specifically for that job.

So now we get to the heart of the question “Why Outsource”? These are a few of our most compelling reasons. “Focus on Core Business”, if your core competency is designing and building cars, it’s probably more cost effective to let the tire maker worry about growing the rubber for the tires. “Restructure Entrenched Departments that are Resistant to Change”, how many times has a company’s improvement efforts been thwarted by a department that refuses to go along with the plan. “Reduce Production Costs to Breathe New Life into a Marginal Product Line”, over the normal course of a products life there is price erosion due to market pressure. “Customer Demand is Out Pacing Production Capacity”, a company can expand production capacity without new capital expenditure. “Second and Third Shift Inefficiencies are Driving Up Costs”, typically shifts other than the primary manufacturing shift have lower production efficiencies.

The next part of the equation is what type of outsourcing to use, there are four basic types. The first and by far the most capital and time investment intensive is the Wholly Owned Foreign Entity (WOFE). In the case of the WOFE the foreign entity would be required to capitalize and staff the factory, in most cases this requires a great deal of money and a constant presence in host country. You can see where this type of outsourcing would be a daunting task. The Joint Venture (JV) is the second type of outsourcing and a very common one. In a JV you would find a company that already fulfills the requirements of facility, skilled labor and so on, and you would either invest in the existing company or form a new company with the existing company. The JV is clearly less capital and time intensive but is not without its drawback’s. The primary detractor of the JV is the matter of control over just about everything, the facility, the personnel, the product and the money. The primary reason that JV’s fail is that the foreign investor losses control over the venture and pulls out so they don’t lose everything. The Strategic Partnership is the third method of outsourcing and is generally fairly successful. The strategic Partnership is simply an agreement between two entities that give roughly equal benefit to both parties. As long as each party performs their part both parties are happy. The last but most common type of outsourcing is using a sourcing company. Sourcing companies are used at a rate of 10 to 1 over the three previous methods combined. The reason for this is simple; if you choose the right sourcing company you get all the benefits of outsourcing while greatly reducing your exposure to the risks. With the proper partner you get to operate as if you are dealing with a local company, but you get the benefit of reduced product cost. A good sourcing company will give you payment terms, manage all aspects of process including quality and material control as well as logistics and work closely with your supply chain management to ensure that there is an uninterrupted flow of quality product.

Companies choose to outsource to China for a variety of reasons such as a broader range of suppliers, components and technology in the lower cost labor market. China also has the advantage of superior investment from government into infrastructure yielding far better transportation systems than their competing countries. Finally, China is very open to western business practices and has a very large English speaking business population.