Understanding Insourcing and Core CompetenciesUnderstanding Insourcing and Core Competencies

GUIDE TO OUTSOURCING

Manufacturers face a variety of challenges in determining the best ways to manage their supply chains. Globalization, multinational corporations, increased competition, and price erosion present both opportunities and pressures that can influence manufacturers as they determine the most cost-efficient and cost-effective means to produce their goods.

As described by Thomas Friedman in his recent book, The World Is Flat, the expansion of global supply chains has sparked a trend toward offshore outsourcing for the production of goods and services.¹

Many medical device makers have adopted outsourcing business practices with varying degrees of success. In general, they face the same issues regarding outsourcing as other industries. If anything, device makers need to be more careful when assessing the quality of an outsourcing partner.

Terminology and History

Insourcing, as it is discussed in this article, is the opposite of outsourcing. Therefore, an overview of insourcing starts with a reference to outsourcing.

Although the terminology can sometimes be used interchangeably, for the purposes of this article, outsourcing refers to the transfer of a manufacturing function to a third party. Offshore outsourcing is used when the third party is located outside the United States.

Outsourcing entered the American business lexicon during the 1980s. Fueled by globalization, the rise in businesses choosing to outsource some or all of their operations was exponential through the 1990s. As the outsourcing trend matured (and many OEMs became disenchanted with the process), another term came into common use—insourcing.

For this article, insourcing refers to the process of bringing products commonly manufactured by third parties or contractors back under the OEM's control. Numerous business journal articles describe the growing popularity of insourcing and highlight the faddish nature of the current debate.

Some of these articles offer alternative definitions of insourcing as a direct opposite of offshore outsourcing. One article, titled “Outsourcing Is Bad, Insourcing Is Better,” uses insourcing to refer to the movement of foreign jobs to the United States.²

Such politicizing can muddy the water for device manufacturers. And although there is no doubt that the topic of outsourcing is somewhat sensitive and highly political, understanding insourcing and outsourcing is more complicated than a cheeky title. Manufacturers may feel strongly about one practice over the other, but each practice has benefits. The main challenge is to look at a manufacturer's individual needs and capabilities to determine the best course of action.

Why Insource?

The easy answer to that question is that, under the right set of circumstances, companies can realize significant savings by insourcing. Return on investment can be seen in as few as 18 months versus the traditional payback of three years on investments that are greater than $7 million–$8 million for capital equipment and tooling. However, device companies considering insourcing need to have the internal technologies and capabilities to support the plans. That includes having solid supply-chain management, appropriate infrastructure, regulatory compliance, and the engineering and technical resources to support manufacturing.

If these needs are met, there can be significant advantages to controlling the supply chain and critical components. The control that comes with insourcing in product quality, delivery lead times, and chain of custody is a significant benefit for participants. Insourcers control and manage needed mold repairs, process changes, and material changes; each of which can affect product costs and performance.

Insourcing can also reduce variability and help the manufacturer develop and test line extensions with a higher degree of security than with outsourcing. A manufacturer's response to a crisis, such as tampering, destruction, or compromise, can also be quicker than if its goods are with an outsourcer. However, both insourcing and outsourcing can help an OEM recover from catastrophes, or alleviate short- or long-term capacity issues.

Insourcers can also enjoy improved responsiveness over contract partners. Because they are closer to their customers, insourcers can react more quickly than those that are simply managing a larger supply chain. With the control of insourcing, relationships can be leveraged for additional cost savings. Insourcing is particularly suited for noncommodity products, because companies can provide competitive quotes and lower their cost of goods sold. Finally, if companies do not achieve quality enhancements through outsourcing, they should consider keeping control in-house.

What about Outsourcing?

The quick answer to the outsourcing question used to be cost reductions. This still holds true for certain products and contexts. With the right partner, outsourcing can provide significant production scale without capital investment.

For small companies with limited access to capital, outsourcing provides a means to manage cash flow and inventories. Outsourcing is a good option for commodity manufacture, because third parties can offer economies of scale that individual companies cannot reach on their own.

The benefits of minimal capital investment and cash flow, however, may be offset by the increased inventory needed to support the long lead times inherent in outsourced manufacturing.

Managing outsource partners may result in greater personnel costs and a loss of flexibility and control. It's also important to understand the implications of outsourcing for inventory and cash flow management. A common issue is deciding when an OEM should pay for its product (upon receipt, ex-works, etc.).

In fact, industry experts note that a key factor driving insourcing has been the failure of outsourcing to achieve the consistent, long-term, and significant cost savings that clients anticipate.³

Estimates from Compass Sourcing Services indicate that large outsourcing contracts show, on average, a cost reduction of 15% in the first 18 months of the agreement. However, experts also say that because of growing demand for services and sales charges of many outsourcing contracts, the client's costs are often 30% higher than those of a well-managed internal operation by the end of the term.³

Another possible drawback of outsourcing material is quality. Although this problem is alleviated by choosing an outsourcer that emphasizes quality, there is a risk that the quality of the product will not meet the expectations of the manufacturer.

There are three key issues to balance in making the decision to outsource or insource manufacturing, as follows:

Products that may require future improvements or updates to address market needs may be difficult to outsource because partners may be unwilling to share in the cost of production changes. Depending on the lead times for manufacture, the volume of in-process inventory may be significant. Finally, OEMs must make sure that partners are willing to alter their processes to accommodate individual needs.

For success in outsourcing, it is critical to pick the right partner. No contract is bulletproof. It is important to understand that unexpected things will happen. OEMs must put plans in place to be ready to manage them when they do. Unforeseen changes in ownership or management can seriously alter a partnership and the terms of supply, price, and quality.

Key Considerations for Insourcing

For companies evaluating insourcing, it is critical to get a clear picture of the costs of manufacturing. Labor costs represent only a small component of the overall cost of manufacturing, for example. For many businesses, the benefits of outsourcing to reduce labor costs are easily offset by the additional costs incurred to manage and support an outsource partner. Such unforeseen management costs can include materials management resources that are used informally for project management. Or, the OEM may need to hire additional management for quality or shipping functions.

The biggest challenge for a device maker is to accurately gauge its own capabilities. One way to assess the possibility of in-house manufacturing is to create a cross-functional team of employees. Give the team time and resources to perform an accurate analysis of the project and provide unbiased recommendations to corporate leadership as to the best approach for the specific project proposed.

Under no circumstances should companies undertake an insourcing project as a fast-track reaction to a short-term supply-chain interruption.
As with all capital projects under review, the consideration of whether to insource production should be given serious review and the appropriate level of due diligence. There are many areas in which teams can be misled in their evaluations, and it is important to be thorough before making an investment in the company's future. Exercise caution, for example, in evaluating overheads. Certain overhead costs are typically undisclosed or the actual overheads are not clearly communicated. OEMs often underestimate the additional management costs of outsourcing. Take the time to undertake a full-blown make-versus-buy analysis with a detailed pro forma financial analysis.

Teams should include individuals that understand the implications for inventory management, such as the strength of the supply chain and the stability of the product design. Determine a strategy to evaluate insourcing to ensure that it is the right approach. For example, new products that require design changes can affect the amount of inventory necessary to support manufacture. Finally, develop a comprehensive analysis for the worst-case, best-case, and most-likely scenarios for the project, so that the range of possible outcomes is clearly defined.

Several key competencies are required for successful insourcing projects. OEMs need to answer critical questions to ensure that these aspects are in place. The most obvious question is: Does your company have the right skill set for the identified product?

An OEM should also establish whether its site has the appropriate infrastructure to support the manufacturing operations. Does the OEM have the ability to set up the facility to support the operations? Is the quality system robust, and are the management resources adequate? Finally, are there capable engineering and technical personnel in place and available to support the project?

There is no question that insourcing gives companies a range of options. The concept reflects the maturity of the outsourcing marketplace, as companies perform true analyses of their needs and requirements to determine what should be insourced and what should be outsourced. As manufacturers gain experience in operations management, their confidence and capabilities can support the business case for insourcing.

Conclusion

Business trends come and go, often leaving the skeletons of well-intentioned companies in their wake. Neither insourcing nor outsourcing is a magic wand for process or profit improvement. Both ideas have their place in today's business environment.

It's important to avoid business fads and trends in approaching the decision to outsource or insource. Each approach has its advantages and drawbacks, as well as opportunities that must be evaluated on a case-by-case basis to ensure that companies are leveraging corporate strengths for the best possible positioning. Any decision should be based on solid analysis and not the latest business trend.

Because of the popularity of the concept of outsourcing, there are many resources in print and on the Internet to help manufacturers review options. Many of these sources provide insight for insourcing. Before you become convinced that any specific path is the right one for your project, take advantage of trade journals, Web sites (such as the Outsourcing Institute at www.outsourcing.com), and other references to learn more about the benefits and concerns that each concept offers. Your project and your business will profit from the investment.

Marian Robinson is vice president of marketing at Baxa Corp. (Denver) and can be reached at [email protected]. Steven van Engen is senior vice president of operations for Baxa Corp.

References

1. T Friedman, “The World Is Flat: A Brief History of the Twenty-first Century” (Farrar, Straus, and Giroux, 2006).

2. J Hearn, “Outsourcing Is Bad, Insourcing Is Better,” in The Hill [online], 9 March 2004 [cited 9 February 2007]; available from Internet: www.thehill.com/news/030904/insourcing.aspx.

3. Bill Fowler, “Is Insourcing the New Outsourcing?” CIO, Analyst Corner (Framingham, MA); available from Internet: www2.cio.com/analyst/report4266.html.

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