Lecture 6a_Insourcing vs Outsourcing

Efficient Supply chains

Designed for efficiency and low cost by minimizing inventory and maximizing efficiencies in process flows:

• Goods/services with highly predictable demand

• Stable product lines with long life cycles

• Low contribution margins

Responsive Supply chains

Focus on Flexibility and responsive service

• Demand is unpredictable

• Short product life cycles

• Fast response is main competitive priority

• Customers require high customization

• High contribution margin

Push system

• Produces goods in advance of customer demand using a forecast and stores them as finished goods

  • Immediate availability of goods to customers

  • Reduce transportation costs through full truckload shipments

Pull system:

Produces only what is needed in responses to customers demand signals

• Minimizes inventory and production costs

Postponement:

Delaying product customization until the product is closer to the customer at the end of the supply chain

Availability of information and communication has made international trade easier

Call Centers for US customers located in India

Developing countries represent opportunities for cost savings and new markets.

• China and India are two well-known examples

• Regions such as Africa and South East Asia represent new opportunities

Outsourcing and offshoring

• Searching for low-cost labor – foreign operations

• Searching for low-cost raw materials – foreign suppliers

• Access to resources

International supply chains

Supply, production, and distribution take place at various facilities location around the world

Vertical Integration

• The process of acquiring and consolidating elements of a value chain to achieve more control

• Typically adds managerial complexity

Backward integration

Acquiring capabilities towards suppliers

Forward integration

Acquiring capabilities toward distribution (or customers)

Opposite is sourcing

Reduces control and increases risks.

Forces Shaping Global SC Decisions

• Market forces

  • Higher than expected demand for new products

  • Competition

• Technological forces

  • New technology like blockchain

• Global cost forces

  • Lower labor costs, raw materials costs

• Political and macroeconomic forces

  • Exchange rates, trade agreements, tariffs, export restrictions, political instability

Risk sources and Their characteristics

Decisions on where to operate or who to source from impact every aspect of the SC

• Sourcing

• Manufacturing

• Transportation

• Distribution

Bottom Line:

Consider the total cost of ownership

Many firms purchase internationally

• International trade complexity

• Logistical differences

• Longer Supply Chain

Global Sourcing

• Access to raw materials (e.g.: cocoa in Ivory Coast, cobalt in Congo)

• Low-cost skilled labor

• Economic factors (e.g.: tax breaks, low trade tariffs)

Global Sourcing

Potential Advantages

• Cost (scale, labor, material, etc.)

• Create a presence in a region/ country

• Competition for domestic suppliers

• Access to scarce materials, products, or parts

• Quality advantages in specific locations

• Technology and innovation

• Currency and other financial considerations

Global Sourcing

Barriers

• Security

• Ethical issues

• Lead time and other supply chain issues

• Higher transportation costs

• Currency fluctuation

• Legal/ Governmental issues

• Regulatory differences

• Internal Communication

• Supplier capability in certain locations

Global Manufacturing

• Shrinking the supply chain

  • End consumers in a foreign country

  • Manufacturing customers

• Potential cost advantages

  • Raw material & energy

  • Investment, economic/tax incentives

• Industry clusters

• Specialized labor

• Government incentives

Global Manufacturing

Potential Issues

• Factory setup

• Government regulations

  • Environmental, safety, financial

• Worker education & skill levels

• Cultural issues

• Infrastructure and Technology

• Distribution complexity

• Longer Lead times

Global Transportation

Potential I

• Lead time requirements

• Transport mode

  • Volume

  • Weight

  • Value

• Customs

• Tariffs

• Local infrastructure

Starting a Global Supply Chain

• Domestic → Regional → Global

  • Going from a domestics to a global scale can be extremely complex

  • Going from domestics to regional or “mega” regional can be a good compromise

• Start in a country that you have existing resources if possible

• Developed countries are good first step

Considering just the direct costs can get companies in trouble... fast

Organization must consider potential risks in their supply chain and take “TOTAL COST” Approach

• Plant efficiency

• Worker Productivity

• Quality

• Transportation differences

  • Raw materials vs Finished Gôds

  • Infrastructure

  • Cost of Emergency shipments

• Political stability

• Acts of God

Starting a Global Supply Chain Recent trends

• With rising labor costs in China

  • Companies are moving to Southeast Asia

  • Companies are moving to Latin America

• Companies are near-shoring

  • Moving production closer to end markets

  • Improve service levels

  • Reduce inventory in transit

  • Increase control over product quality

• Companies are reshoring

  • Returning to home country

Break-Even Analysis for Outsourcing Decisions

A firm is evaluating the alternative of manufacturing a part that is currently

being outsourced from a supplier. For an in-house manufacturing, the annual

fixed cost is $45,000 and the unit cost per part is $130. Currently the unit cost

of purchasing the part from the supplier is $160. The demand forecast is 1200

units

1. a) Compute the cost of manufacturing in-house and outsourcing. What decision should the firm make?

2. b) Determine the break-even quantity for which the firm would be indifferent between manufacturing the part in-house or outsourcing it

3. c) What is the maximum price per part the manufacturer should be willing to pay to the supplier if the forecast is 800 parts?

1. a) Compute the cost of manufacturing in-house and outsourcing. What decision should the firm make?

   • C_in-house = FCI + CI x Q = 45000 + 130 x 1200 = 201,000

   • C_outsource = FCO + CO x Q = 0 + 160 x 1200 = 192,000

   • The firm should outsource

2. b) Determine the break-even quantity for which the firm would be indifferent between manufacturing the part in-house or outsourcing it

   • Q* = (FCO – FCI)/(CI-CO) = (0-45000)/(130-160) = 1500

3. c) What is the maximum price per part the manufacturer should be willing to pay to the supplier if the forecast is 800 parts?

   • C_in-house = FCI + CI x Q = 45000 + 130 x 800 = 149,000

   • Co_{at 800 units} = 149,000/800 = $186.25

   • The firm is willing to pay under $186.25 per unit for outsourcing