When the Outsourcer Starts Outsourcing (Make vs. Buy Decision)

Outsourcing can be defined as hiring an outside vendor to produce a product or service. This involves a make vs. buy decision. Is it cheaper to produce the product yourself, or pay an outside vendor to make the product for you? A few tips regarding make vs. buy:

•          If you make the product yourself, you’ll incur the variable costs (mostly labor and materials) to make the product. If you’re making blue jeans, for example, you pay for denim material costs- and for labor costs to cut and sew the blue jeans.
• 
  
•           When you consider outsourcing, the purchase price charged by the outsourcing company is part of your total product cost.
• 
  
•            If you choose to outsource, some of your fixed costs may be eliminated. For example, you may not need certain employees that were managing production. However, you may not get rid of all fixed costs. If you have a long-term lease for a factory building, you may have to continue payments- even if production stops.

While it may be cheaper to outsource, there are other considerations. The outsourced product needs to be of good quality- and completed on time. If not, your production process may slow down (while you wait for the outsourced product). If you ship a poor quality product (or product component) to a customer, the product may not work correctly. That issue can upset your client.

For decades, companies in the U.S. and Europe have outsourced production to China. The outsourcing made economic sense, because the labor rates in China were far less than those in other parts of the world. Now, that’s changing.

A recent Wall Street Journal article, (“China Manufacturers Survive by Moving to Asian Neighbors”, 5/1/13), reports that after “decades of nearly 20% annual wage increases in China”, production is leaving the country. Rather than continue production in China, companies like Nordstrom and Crocs are moving to Vietnam- where labor costs can be 50% of the Chinese rate.

In many cases, The Chinese company keeps responsibility for producing the item. They simply outsource the physical production to a country with a lower labor cost rate. It’s an example of an outsourcer doing some outsourcing(!)

One last thought: If production is leaving China, how does China replace those jobs? Like other countries, China is attempting to move to higher skill, higher wage industries. It’s a trend that you see in many countries as they develop economically. Instead of manufacturing the next great product innovation- Chinese companies want to create the concept- and manufacture the product somewhere else.

Check out the website for the Subscription-only newsletter, and my Toughest Accounting topics live chats: stltest.net.

Thanks!

Ken Boyd

St. Louis Test Preparation

(cell) (314) 913-6529

(email) ken@stltest.net

(website) www.stltest.net

(you tube channel) kenboydstl

(blog) http://accountingaccidentally.blogspot.com/

(facebook-2 pages) St Louis Test Prep and Cost Accounting for Dummies

(twitter) @StLouisTestPrep                         

Author/ Cost Accounting for Dummies

(amazon author page) amazon.com/author/kenboyd