Fact or fiction? Third-party manufacturing services can make supply chains more efficient. The answer varies from company to company and product to product, but many leadership teams will never know because they assume outsourcing is more expensive and overlook its strategic potential. Most companies use third-party manufacturers only to solve short-term capacity constraints.
That’s a missed opportunity. Best-in-class manufacturers are discovering that a thoughtful approach to outsourcing can help increase their competitive edge. In fact, buying a product instead of making it may prove more efficient once leadership teams add up all the costs of in-house production, many of which are hidden. One example is the added organizational complexity that comes with building and managing production lines as part of a broader network. Leaders also know that outsourcing can improve quality and reduce time to market. To get to the correct answer for each product, executive teams need to analyze all of these factors.
Take the case of one global consumer electronics company that needed to add more flexible manufacturing capacity. When it ran the numbers, the leadership team realized that continued investment in internal capacity would have a low return on investment. The company’s analysis showed that outsourcing would reduce manufacturing costs by roughly 5% while also increasing flexibility. In addition to cost savings, the company benefited from redirecting capital that it would have invested in the network to other core activities that fueled growth.
The leadership team decided to outsource more than 60% of its products and sell several of its manufacturing facilities to a global electronics manufacturing service provider. That move allowed the company to stop making products low in intellectual property content and redirect capital toward products with higher IP content.
Leading manufacturers avoid making a decision about outsourcing based solely on unit cost. Instead, they routinely review whether outsourcing could provide strategic benefits by comparing internal and external production options across a variety of metrics, including flexibility, speed and access to technology.
One of the most overlooked advantages of outsourcing is rapid access to new capabilities or technologies that can speed development, lower costs and improve quality. Access to technology may help a company increase the competitiveness of its core products or get new products to market faster. That was the case for a leading appliance maker that turned to its manufacturing services partner for product development support. The research and development collaboration helped the appliance maker redesign some of its appliances for improved production efficiency. The manufacturing service partner used standard in-house designs, switched to standard off-the-shelf parts, and designed the product for better manufacturability and costs. The results were lower lead times, higher quality and lower overall total cost of ownership.
Companies may also benefit from outsourcing products with low or fragmented production volumes since they often diminish the firm’s ability to focus on its core products. One food and beverage company collaborated with a third-party manufacturer to increase production capacity and ensure a secondary source for its largest and fastest-growing product. The company’s decision to outsource production lowered its overall cost per unit, reduced fixed costs and increased production without adding new facilities.
Even when management teams decide to keep production in house, the evaluation process can unearth new opportunities for improving flexibility, increasing manufacturing speed and lowering costs. The global electronics company mentioned above received more than 20 ideas from its third-party manufacturer on how it could improve the efficiency of its production process.
Similarly, a North American consumer electronics company seeking to double its sales within three to five years decided that partnering with an electronic services manufacturer would provide not only the extra capacity it needed but also access to world-class capabilities such as digital manufacturing, the Internet of Things and automation technology.
Of course, it’s a two-way street. Some companies that outsource may discover strategic reasons to shift manufacturing in house, including a recently lowered cost structure or plans to add IP to a product.
Outsourcing isn’t always the answer, but the myths surrounding it have tarnished its reputation. Successful companies regularly analyze all the factors to determine when third-party manufacturing can help them build a more productive, cost-efficient supply chain—and get a leg up on the competition.
Rob Ruffin is an expert vice president with Bain & Company’s Performance Improvement practice, and he is based in Boston.