Viewpoint: When Companies Shouldn't Outsource Manufacturing

April 10, 2012
Six situations where manufacturing is best left in-house.

The trend to outsource manufacturing has been going strong for two decades. Recently, it has been popular to speculate on whether this trend has gone too far. In the developed Western economies, much is being written about bringing manufacturing back in-house. This discussion often seems to focus on inflation in China, or a political desire to protect manufacturing jobs at home. But reasoning based on parochialism and wishful thinking will not change the economic motivation of an individual firm. The world will not soon become less global, and significant wage and operating cost differentials between developed and developing economies will continue to exist for a very long time. Nevertheless, there are still many cases where a company may benefit by choosing in-house manufacturing over outsourcing -- but only when these cases truly apply:

A company's manufacturing process is the source of its competitive advantage. One example of this case is microprocessors, where the ability to manufacture smaller and smaller geometries directly affects product performance. If you believe your company's manufacturing process provides a true competitive advantage, there is a critical strategic implication: You must continue to advance the art and lead the technology curve for that manufacturing process. If you stand still while others move forward, you will lose your competitive advantage. At the point that process innovation is more likely to come from outside your company than inside, you have to reconsider your strategy.

A firm does something in a unique way and does not want competitors to know how to do it. It is not hard to mix sugar and flavors into soda syrup, but Coca-Cola is not likely to outsource it. Trade secrets -- if they are really a source of sustainable competitive advantage -- should not be outsourced. Keep in mind that just because we do it our own way does not mean it is the same thing as a trade secret that provides competitive advantage.

A competitive market for the specific manufacturing service does not exist. Even if the firm chooses to use just a single outsourced manufacturing supplier, they need access to other providers in the market to quote competitively or they risk operating in an inefficient manner or even being held captive.

There is no opportunity for the service provider to leverage their fixed capital, common overhead, specific purchasing power, or expertise. Always remember the original economic proposition that enabled manufacturing outsourcing to become widespread in the first place. By aggregating the demand, an outsourced supplier can improve utilization, increase buying power, and leverage their overhead and experience across many customers. If the work you want to outsource doesn't have processes or materials in common with what the outsourced provider is doing today, then outsourcing is unlikely to provide the value you expect.

To capture a limited and critical resource or channel. Supply chain bottlenecks can be an opportunity to create strategic advantage by taking those sources away from potential competitors. I once worked for a company that made inductive heaters. The heater wire had unique braided insulation. While it was otherwise an easy part to outsource, we bought all the equipment from our supplier and made our own wire in order to prevent competitors from selling replacement heaters using the same wire.

It is too costly to outsource the manufacturing process because of the additional costs driven by outsourcing. Everything that gets sourced outside the firm drives transaction costs -- the expenses and risks associated with such things as finding suppliers, quoting, negotiating, verifying performance and managing the suppliers on an ongoing basis. Sometimes, outsourcing a manufacturing process would otherwise make sense when considering manufacturing strategy and direct purchase price, but the transaction cost is greater than any potential savings or benefit.

Manufacturing outsourcing is not going away, but the choice to outsource should be both a thoughtful economic decision and most importantly a strategic decision.

Jeff Wallingford is vice president, Supply Chain Strategy for Riverwood Solutions.

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