Published June 1, 2006
Most businesses today are either outsourcing certain functions or considering it. But this is a major decision, and the benefits can be difficult to define. The benefits discussion typically centers on cutting costs. Outsourcing has been sold by the market or by clients as a way to cut costs by reducing overhead and having a professional perform the operation. While this benefit is attainable, it is not the only advantage and should not be the only reason a company decides to outsource.
The benefits of outsourcing can be divided into two types. First, there are the direct benefits-those that have an immediate impact. Then, there are the indirect benefits-the impact that outsourcing has on the processes that have remained in house.
The direct benefits of outsourcing are those related to reduced costs, decreased cycle times, and improved customer perception and satisfaction. They include:
- Focus on core competency
- Reduction in the cost of manufacturing and logistics services
- Reduction in head count of hourly workers and management
- Improved accuracy
- Flexibility and wider range of services
- Access to global networks and superior technology
- Improved service
- Improved quality
- Reduced capital investment and increased cash flow
Focus on Core Competency
A company that outsources manufacturing, logistics, or both no longer needs all the resources it has been using to make a product, store it, and get it to customers. Therefore, the company can redirect these resources to its core functions.
This kind of focus can only improve core functions. For example, if a company has decided that its core competency is product design and engineering, outsourcing the product’s manufacture means that the design and engineering can get better because that is now the company’s main focus. Workers will not be spread too thinly, managers will have time to focus more on the design process, and leaders can concentrate on new engineering and design as opposed to manufacturing and distribution. The result is likely to be superior design and an improved product because it will have been produced by a company whose sole purpose is to manufacture a product developed by a company that knows design better than any other.
Reduction in Cost of Manufacturing and Logistics Services
When a company outsources manufacturing, logistics, or both, it can consolidate operations. It no longer has to maintain factories and distribution centers. Therefore, the manufacturing and logistics costs to the company that has outsourced are often lower because they are no longer responsible for physical plants and personnel related to these functions. Also, the vendor might be providing a shared service, so the company is not paying for under-utilized capacity, which will in turn lower inventory-carrying cost.
Reduction in Hourly Worker and Management Head Count
The kind of streamlined, lean company that succeeds in today’s marketplace must do so with fewer employees than the companies of the last generation. This is a hard fact for many workers to swallow-whether they are order pickers, plant supervisors, or production managers. Downsizing, mergers, acquisitions, and elimination of product lines will not go away.
Outsourcing operations is one of the most effective methods for reducing head count. Instead of reducing head count with a mandate that each department cut 2.5 employees while keeping workload constant (or in many cases, increasing it) entire departments are cut along with the workload. This means departments that will maintain and grow a company’s core competencies do not lose valuable personnel or have more responsibilities due to increased workload. In return, the personnel used by outsource service providers are trained professionals, many of whom are stars in their respective functions. In some cases, outsource service providers will even hire workers from the companies that engaged them. This becomes a benefit for workers because now they are the stars in a company whose core competency is their profession, giving them greater opportunities for growth.
The following scenario is a good way to illustrate how outsourcing can improve accuracy. Imagine a busy Saturday at your house. You have a long “to do” list which includes picking up the dry cleaning, mowing the lawn, buying snacks and drinks to hand out to your children’s soccer team after the game, and doing your taxes. While you are shopping, your mind is in a hundred places at once and when you get home, you find that you did not buy enough drinks for the soccer team. Now suppose you hired a neighborhood teen to mow the lawn, asked your spouse to pick up the dry cleaning, and put your taxes in the hand of a paid accountant before you went shopping. You would probably get the right amount of drinks because you were able to focus on the core task of shopping and not even think about completing the other tasks.
Now, suppose you have taken a look at your household and realized that there is more at stake than a quiet Saturday or a few drinks at a soccer game. After talking things over with your spouse, you decide to hire a nanny. Now, drinks are no longer an issue because you have a nanny to handle those kinds of chores. This allows you to concentrate on other household matters, and you can do a better job with them.
Although these are simple analogies, imagine the impact this scenario has in a more complex environment. When someone (either inside or outside the company) only has to perform one task, it is likely that task will be completed more accurately. If all you have to do is inventory, then your inventory count is more likely to be accurate than if you also have to supervise several plants, pay department bills, maintain a global network of distribution centers, and so on.
Flexibility and Wider Range of Service
If you think that focusing on a core competency and outsourcing the rest is limiting your company, you might want to think again. If you outsource non-core functions, be they primary or secondary, your company has no limits. Let’s revisit the busy Saturday scenario. If you have others helping you tackle your “to do” list, there are fewer limits on your time and energy. For example, you can plant bushes or trees in your front yard because someone else has mowed the lawn. Or, you can hire a landscaper to do the planting, and so you can offer more to your family and neighborhood.
Just think of what you can accomplish if you apply your Saturday strategies to your company! You can offer your customers more because, although the company may actually be doing less within its four physical walls, it is accomplishing much more. Your company can produce more, ship greater amounts, and break into product lines heretofore not considered because everything is not being done in-house.
Access to Global Networks and Superior Technology
Contract manufacturers and 3PLs are certainly not new. Many have been doing what they do best for decades. As they have acquired more clients and become more established, contract manufacturers and 3PLs have built sophisticated relationships. Many also belong to multilevel networks that are so necessary for remaining competitive and winning in an established global marketplace. They are also using the superior technology associated with world-class manufacturing and distribution operations, including warehouse management systems (WMSs), transportation management systems (TMS), manufacturing execution systems (MES), and operations management systems (OMS). A company hiring one of these providers has the opportunity to access the provider’s multilevel logistics networks and technology.
During the years of the e-business boom, software vendors like Descartes and Nistevo began linking carriers, suppliers, and purchasers in collaborative networks that have continued to grow even after the dot-com bust. A number of outsourcing providers are plugged into these networks, and that puts these resources at the disposal of any company that engages them. Contract electronics manufactures like Flextronics and Solectron also have access to networks, and now these networks are part of their offerings to customers.
Using outsourcers such as these organizations means that a company does not have to build complex networks on its own. Smaller operations can share space, as well as IT support and operations, and all companies can leverage provider networks to consolidate loads. For example, the largest 3PLs support regional cross-docks in far more areas than any one company does. This broader network offers the opportunity to consolidate shipments more efficiently to reduce transportation costs.
Outsourcing manufacturing and logistics improves service by shortening cycle times and speeding time to market. Tapping into capabilities not available internally increases scheduling flexibility and resource availability, which usually results in reduced time to market. BMW, for instance, wanted to bring its lower priced X3 SUV to market quicker, so the company outsourced its manufacture to Magna Steyr, an Austrian carmaker.
3PLs receive and store raw material or finished inventory, consume inventory in the production process, produce finished goods, and ship finished goods to customers-all the while maintaining inventory. So, improved inventory visibility and accountability, as well as on-time delivery, are all part of their packages. This ensures higher levels of customer satisfaction.
Interestingly, many companies that have already outsourced manufacturing, logistics, or both originally did so to cut costs; however, they have now found that not only can outsourcing reduce overhead, it can also improve quality. This quality improvement is due to the fact that outsourcing providers running volume operations have better quality assurance (QA) programs in place than the average company that is still trying to do it in-house. According to Gary Koh, CEO and managing director of Genesis Advanced Technologies, “Their critical mass in a particular discipline allows them to develop reliable processes including quality control.” The results are less damage, less rework, improved response time to inquiries, and greater inventory accuracy.
Reduced Capital Investment and Increased Cash Inflow
Outsourcing manufacturing, logistics, or both will reduce capital investment. This is because once these processes are contracted out, the facilities previously used by the company are removed from the balance sheet. If you no longer make or assemble your product, then you no longer need to maintain factories. If you have outsourced distribution, then you no longer need distribution centers or warehouses. This makes capital funds more available for a company’s core functions. Outsourcing can also eliminate the need to demonstrate return on equity from capital investments in non-core areas, and this can improve certain financial measurements.
So, what do companies do with assets they no longer need? They sell them. Equipment, facilities, vehicles and licenses used in current operations all have a value. Often, companies can sell them to the outsource provider at book rather than market value, or they may find a market for them elsewhere. But whether they sell unneeded assets to the provider or to another party, companies still end up with an infusion of cash, either because they don’t have the expense of maintaining the facilities and equipment or because they sold them.
The indirect benefits of outsourcing are usually not as easily defined and are an unexpected surprise when realized. And when achieved, they have a subtle effect on the company’s bottom line. Indirect benefits include:
- Creating a catalyst for change. In the search for core competencies, how outsourced operations are managed is highlighted. Companies can take a closer look at engineered operations, planning, and scheduling. The result is a better grasp of accountability and root cause analysis, which can only improve core functions.
- Initiating or fueling change. A company is often able to offer new services and capabilities because outsourcing has increased performance in the form of shorter lead times and reduction in the landed cost to the customer.
- Stimulating analysis. The requirement to document business processes (and their costs) inherent with any outsourcing implementation often uncovers valuable information that can be studied and put to use within the organization. In other words, developing metrics to use to select a third-party provider may result in asking why these metrics aren’t used throughout the company.
- Converting sluggish functional areas into dynamic ones. The actual process of finding a provider and performing a baseline analysis will cause a company to look internally to improve processes. This often breathes new life into functions such as customer service, purchasing, and procurement.
- Resource and contact development. After a successful outsourcing implementation, companies often find they have access to new business resources and personnel, such as freight handlers, value-added service providers, and IT. Using these contacts, they can form new beneficial relationships.
When both the direct and indirect benefits of outsourcing are laid out, it’s easy to see why so many companies are already outsourcing or planning to do so. A company that outsources operations has much to gain. Yes, there are risks. Yes, it is possible that an outsourcing strategy will fail. But if you know how to approach outsourcing or work with experts who have made outsourcing a core competency, the benefits far outweigh the risks.