PURCHSING & SCM

PRCH-1020

Module 5

Chapter 6 – Insourcing,
Outsourcing, Making or Buying
 Agenda
 What is outsourcing, what is offshoring? What is insourcing?
 What are the reason companies outsource?
 What are different types of outsourcing examples
 What are the advantages and disadvantages of outsourcing?
 Drawbacks companies face when they outsource their activities
 What are the fundamentals of the decision to make or to buy
 What needs to be considered in the cost analysis?
 Class activities #1, #2, #3
 Objectives
 Explain why organizations outsource
 Learn the make or buy decision analyiss
 What potential advantages or disadvantages the organization will need
to consider.
 Identify the advantages and risks associated with outsourcing
 Compare the costs associated with buying or making a product
What is outsourcing and offshoring?
Outsourcing and Offshoring

Outsourcing
 Is the act of using another company to provide goods or services that your
company requires.
 Company looks for outside companies can add the most value to their products
at the least cost.
 It starts with a question - why do something yourself if someone else can do it
better or more cost-effectively

Offshoring
 Outsourcing work to companies abroad is called offshoring
What are the Reasons Companies
Outsource?
Reasons companies outsource?

 Beginning in the 1990s

 To lower costs.
 To focus on the core competence companies do best.
 Gives companies access to high value talents, skills and technology.
 Helps companies improve service quality.
 Gives companies advantages against their competitors
In addition to products, what are the
other different types of outsourcing
 What are the different types of outsourcing examples
Rather than own fleets of trucks, ships, and airplanes, most companies outsource some of their
transportation tasks to shippers such as UPS, Purolator, FedEx. Some companies hire freight forwarders to
help them.

1) Forwarder
• A travel agent for freight.
• It doesn't own its own transportation equipment or warehouses
• Their duties include negotiating rates for shipments and booking space on transportation vehicles
and in warehouses.
• Also combines small loads from various shippers into the larger loads that can be shipped more
economically.
 What are the different types of outsourcing examples

Some companies go a step further and outsource their entire order processing and shipping departments
to a third-party logistics (3PLs) firms.

3PL
 One-stop shipping solutions involves
• Transporting products,
• completing import and export paperwork,
• receiving and storing products and materials, inventory management,
• warehousing and fulfillment.
• Other value-added services, quality inspections, labelling
 What are the Advantages and
Disadvantages of Outsourcing?
 Advantages of Outsourcing

 Utilizes external expertise, removes the need for in-house expertise

 Frees up capacity for other uses

 Allows management to focus on competitive strengths

 Transfers some production and technological risks to the supplier

 Disadvantages of Outsourcing
 Loss of control of product quality and safety.

 Loss of control of technology.

 The longer period of time it takes for the products to make their way to the hands of consumers.

 Takes away control over quality and timing of production

 May limit ability to upsize or downsize production

 May have hidden costs and/or a lack of stability of price

 Often makes it difficult to bring the production back in-house once it has been removed
What are the Main Outsourcing
Challenges?
 Main Outsourcing Challenges
 Company reputations:
e.g. Mattel, the toy supply corporation, was forced to recall tens of millions of toys outsourced for
production in China, toys were tainted with lead. Mattel isn't the only company to experience problems.
.

 Quality Control:
 U.S. Consumer Products Safety Commission randomly inspects products, but there is no way the
commission's personnel can test all products.

 To protect the customers, many companies either test their suppliers' products themselves or
contract to the independent labs. For example, if you sell a product to Walmart, suppliers need to be
prepared to send it to such a lab.

 Some corporations station QA employees with their suppliers on a permanent basis to be sure that
the quality of the products they're producing is acceptable.
Why Some Companies Insourcing?
 Why Some Companies Insourcing

What is insourcing?
 When firms can't resolve their supplier problems, they find other suppliers to work with or they move the
activities back in-house, which is a process called insourcing.

e.g 1) Retailers don't like to wait for products. waiting maybe mean their customers will shop elsewhere
if they can't find what they want. For this reason and others, some companies insource their products
closer to home.

 Dependence risk: overdependence can lead to increased costs and reduced bargaining
power and other risks.
 Political environment
 Tariffs enforcement, E.g. EV, steel, aluminum, gloves for medical field, manufactured in China
What are the Fundamentals of the
Outsourcing Decision to Make or to
Buy?
 Fundamentals of the Outsourcing Decision to
Make or to Buy

The decision of make - buy involves analyzing the critical factors:

a) All relevant costs

b) Ability of outsourced company to meet delivery requirements

c) How outsourcing displaces workers or hamper current employee's morale.

d) How outsourcing may affect the reputation of the company.

What Needs to be Considered in the
Cost Analysis?
Things need to considered in the cost analysis
Make-Buy cont’d
Thermal Mugs, Inc
The cost to produce a new lid is $2.19 each
Annual quantity to produce: 120,000

Supplier Plato Plastics made an offer $1.75 each, can we make a decision to buy?

Current cost of making in house per unit

Things need to considered in the cost analysis
Make-Buy cont’d
Consideration: If we outsource, what costs can be avoided? What costs can not be avoided

direct materials, direct labour, and variable overhead—avoidable cost

Fixed cost: fixed costs are not tied directly to the production of the lid, e.g. insurance, interest
rates to banks, taxes to government, electricity, hydro bills , will still exist even if the lid is
purchased from Plato. That means fixed costs ($0.51)- unavoidable cost
Things need to considered in the cost analysis
Make-Buy cont’d
2 scenario analysis
• Table 1 wwithout fixed cost: Make or Buy?
• Table 2 - with fixed cost, unavoiable but can be reduced: Make or buy?
• Conclusion: If we outsource, analysis should be including what costs can be avoided? What costs can
not be avoided
Things need to considered in the cost analysis
Make-Buy cont’d
Final Analysis of the Decision: Qualitative and Quantitative.

Improper cost identification can lead to bad decisions – above quantitative analysis is only
part of consideration for make-buy decision

1) Qualitative factors need to be considered

• Will Plato meet the quality requirements ?
• Will supplier Plato continue to produce the lid at the $1.75 price, or is this a teaser rate
to obtain the business with the plan for the rate to go up in the future?
• Outsourcing the lid, may displace the employees , does it hamper employee’s morale?
• Buying the lids from supplier, does it affect the reputation of Thermal?
• If supplier Plato fails to deliver the lids on time, this can negatively affect Thermal's
production and sales
• If the lids are of poor quality, returns, replacements, and the damage to Thermal's
reputation can be significant
• Advantage: 1) save money 2) free up production capacity to produce other products
lines.
 Class Activities
 Total cost per unit = Fixed Costs + (Variable Cost per product *
Quantity) + Internal Costs
 Class Activity #1
You are the supply chain manager for Pressed & Co., a fresh pressed juice company that
wants to sell the juice in a large size than your current 355ml bottle. Pressed & Co. will need
3,000,000 bottles for next year. Your company can produce the bottles in-house (make) or
can purchase them from an external supplier (buy).

Complete a make or buy analysis using the following data to determine what
option is best, quantitatively.
Make Option:
 Fixed Costs: $600,000 per year (for equipment, maintenance, and overhead)
 Variable Costs: $0.08 per bottle (for raw materials and labor)
 Internal Costs (additional overhead, quality control, etc.): $100,000 per year
Buy Option:
 Supplier A: Fixed Price: $0.13 per bottle (no additional fixed costs)
 Supplier B: Fixed Cost: $200,000 per year, plus $0.10 per bottle (variable cost)
 Supplier C: Fixed Cost: $150,000 per year, plus $0.11 per bottle (variable cost)

What other considerations does Pressed & Co. need to consider before making a
final decision?
Class Activity #2

•Make or buy – Case

Study
•Metrovox
 Class Activity #3
Reuben's Deli currently makes rolls for deli sandwiches it produces. It uses 30,000 rolls
annually in the production of deli sandwiches. The costs to make the rolls are

A potential supplier has offered to sell Reuben the rolls for $0.90 each. If the rolls are
purchased, 30% of the fixed overhead could be avoided. If Reuben accepts the
offer, what will the effect on profit be?
a) Profits will decrease by $1,200
b) Profits will increase by $3,000
c) Profits would increase by $1,200
d) Profits would decrease by $3,000
Assignment:
• Submit Supply Chain Project Part 2 – Make or Buy , due last day of
this module

Working on
 Supply Chain Project Part 3 – Finding Suppliers due last day of
Module 6.

Next week
 Module 6 – Finding, evaluating, and selecting suppliers
 Read Chapter 3 - finding suppliers
 No class for Section 03 on Monday Thanksgiving holiday , Class 03
and 02 will be in Classroom T2007 on Tuesday, 6: 00 pm to 8:00
pm,