Latest Word on Outsourcing

15 Feb, 2006 By: Jeffrey Rowe

This ongoing manufacturing dilemma has some new twists

Although a lot of them have taken a beating of late, many U.S. manufacturers seem to be somewhat upbeat about the U.S. economy over the next 12 months. Despite this outlook, however, the manufacturing sector continues to be more pessimistic than the broader marketplace about the state of the economy.

The latest economic indicators do, however, offer some hope to an industry sector that has seemingly been in a downward spiral for some time now. Be mindful, though, that manufacturing is not just experiencing a downturn, but also is undergoing a fundamental and thorough restructuring. Many organizations, large and small, have realized that to remain competitive (and in business), they must develop entirely new business models. In many sectors of manufacturing, business as usual will not cut it. Throwing technology at problems in manufacturing can help to a certain extent, but just as important is paying more attention to business and management processes that allow manufacturers to be more adaptable to ever-changing customer needs.

Outsourcing Today

Another factor in manufacturing progress today is the evolving practice of outsourcing, something I have discussed here several times.

“Should we build it in-house or buy it through outsourcing?” This is a question that has becomes more critical for manufacturers. Does it make sense for a company to maintain control of its manufacturing facilities, ensuring supply in times of need (and risk overcapacity when things slow down)? Or should the company outsource? If so, to whom and to what extent? Should the company try to combine the supply techniques? If so, how? And are there other alternatives to consider?

These are tough issues that manufacturers are increasingly forced to grapple with in an economy that penalizes inefficiency and rewards lean processes. Under these circumstances, outsourcing at least a portion of production seems like a wise choice. As a matter of fact, it often is a very wise choice for certain industries. For example, contract manufacturing of electronics passed the $100 billion-per-year mark several years ago and had a positive effect on several OEMs. New approaches to negotiating contracts between OEMs and contract manufacturers can significantly improve margins for both parties.

But, solving the build vs. buy dilemma can pose as many strategic and tactical questions for outsourcing OEMs as it resolves. The classic manufacturing model is built on a vision of a vertically integrated organization: Production is performed in-house, as are activities that stimulate demand in the marketplace, including R&D, product design and marketing. The result is what most companies would agree constitutes innovation. Outsourcing to contract manufacturers may actually harm some OEMs (and market development) by reducing incentives to innovate.

Everybody in the Pool

An alternative exists to going it alone, and is sometimes a better strategy. An OEM can retain production capacity by pooling resources with other similar firms through supply contracts or a joint venture. Although generally not well-known, this type of outsourcing is actually quite widespread in the electronics and automotive industries. I would venture to guess that the OEM outsourcing market -- that is, OEMs building things that are purchased by other OEMs -- is at least as large as the market for outsourced contract manufacturing.

I would also suggest that pooling resources can lead to greater innovation. For any fixed level of capacity, an increase in market size for one's products leads to a more efficient use of that capacity. Pooling reduces production expenses, which encourages OEMs to invest more in innovation. Innovation also increases potential market size because the benefits of designing more variations of a given product are greater with a larger potential market that includes other OEMs. OEMs who don't pool will generally view these variations negatively because of their extra expense and greater risk. But when capacity is pooled, additional resources are available to make variations, and although this does involve extra expense, that expense is shared to a degree -- making the new products less risky. So, OEMs that pool resources often do have real incentive to innovate.

Outsourcing is still trying to find its true place in today's manufacturing world, but it's a practice that is becoming increasingly critical for many types of manufacturers as they struggle to thrive, or even survive. Outsourcing certainly can have benefits, but is also subject to just about as many pitfalls for the unwary. Of course, the trend that receives the most notoriety is that of offshore outsourcing -- the politically correct term is global outsourcing -- not just in manufacturing, but for IT, technical support, even design and engineering. Will this trend reverse itself? Highly unlikely. However, put in the proper context, global outsourcing can be more of an opportunity than a threat. Yes, it might force many manufacturing workers to learn new skills, but at the same time will enable them to continue to do what they do best -- and even become more entrepreneurial. Not necessarily a bad thing.

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