To outsource or insource: that is the question for many companies who rely on the production of goods. And over the past few years, with the arrival of global communication, this conundrum has become more relevant to businesses of all sizes.
After the most recent recession, the scales began tipping in favor of domestic manufacturing. According to the results of the Global Outsourcing Survey of 2012, “political sentiment, wage deflation, and high labor supply” forced U.S. companies to return to back to homeland manufacturing. Companies, SMBs included, wanted their products made in the good ol’ U.S. of A.
So now that we’re well into 2015, is offshore production dead?
With 54% of executives from billion-dollar U.S. manufacturing companies hoping to shift production to the U.S. from China, the answer would seem to be “yes”. But outsourcing isn’t necessarily dying, per se, it’s just that the state of manufacturing is evolving.
Related Article: A Startup’s Guide to Outsourcing Tasks and Duties
Benefits of Insourcing
In 2008, GE’s CEO Jeffrey Immelt tried to sell their manufacturing facilities at Appliance Park, as most of their production was done in China or Mexico. Just four years later, Immelt spent $800 million to revitalize the place, claiming that offshore manufacturing is obsolete and the investment would have a ROI. He was right. They cut material costs, nixed unnecessary processes and decreased time to market.
From a business standpoint, keeping production on domestic soil has many advantages:
- Having control of logistics and quality control
- There are no third party hidden costs
- No international regulations to worry about
- Proprietary information remains confidential
- Other outsourcing risks are mitigated
- Overlooking innovation opportunities
Perhaps the biggest reasons companies have been moving back home are these: China’s labor costs aren’t as low as they once were and shipping costs are no longer attractive. The average pay in Asia almost doubled from 2000 to 2011, and now the low-cost myth of outsourcing isn’t a stable reality.
We’ve all heard the horror stories of offshoring as well—Nike’s sweatshop allegations, Mattel’s many toy recalls, and the Foxconn suicides in Apple’s contracted manufacturing facilities. These stories are enough to scare the small business owner away from partnering with factories abroad.
Such horror stories have influenced consumer buying habits as well. According to a survey by Mellman Group and North Star Opinion Research, 90% of consumers say they have a favorable opinion of domestically manufactured products.
Unfortunately, re-shoring isn’t always the best option for entrepreneurs. Domestic manufacturers often don’t want to deal with shaky startups, as they aren’t a financial priority, which pushes many small businesses to partnering with overseas manufacturers.
Benefits of Outsourcing
Although re-shoring has made a comeback in previous years, outsourcing is still viable for many companies. The benefits of manufacturing include:
- Overhead cost savings
- Forgoing the manufacturing licensing process
- Ability to focus on other aspects of business
- Close to export countries
- Third party technical or industrial expertise
Companies like Apple and Nike, although they have dealt with outsourcing indignities in years past, still rely heavily on Asian manufacturers. Selling products in such enormous demand, these companies have little choice. According to the NY Times, 90% of iPhone components are manufactured abroad.
The amount of technical expertise is vast in places like China. Apple executives estimate that it would take nine months to find the amount of qualified engineers to oversee an assembly line. In China, it took all but 15 days.
Related Article: Going Global: How to Tap Outsourcing to Take You Higher
Executives are increasingly focused on producing things locally. In fact, 35% of the executives who responded to a Boston Group’s survey said “proximity to customers will drive their decisions about where to situate production”. Rather than focusing on U.S vs. Overseas, McKinsey & Company analysts claim, companies should focus on the proximity to delivery and innovation. And having manufacturing plants in China is beneficial to companies looking to expand into the Chinese market.
"I don't think companies are going to pull out of China," Hal Sirkin with the Boston Consulting Group told the Huffington Post. "Because of Chinese domestic demand which is growing at 8 or 10 percent a year, even if they decide to pull out their export plants they will then convert those plants, basically re-tool them into Chinese consumption because there is a great market in China given all that growth."
Make or Buy decision
Whether you opt for foreign production or choose to manufacture in-house, you must do an incremental analysis unique to your business goals to arrive at a “make-or-buy decision”. Here’s how to make that verdict:
- Calculate the incremental cost to buy from a manufacturer (price per unit multiplied by total units)
- Calculate the incremental cost savings (the cots of material, labor, and factory overhead you would incur if manufacturing in-house)
- Calculate opportunity costs (potential opportunities if outsourcing, i.e. leasing out old factory space, ROI on putting that time and money elsewhere)
In this UNF example, the cost to outsource outweighs the expenses of internal manufacturing.
There are however, more qualitative issues that could affect your profit just as much as incremental costs. For example, the quality of the outsourced product, the timeliness of delivery, and affects on internal employees.