Deciding to manufacture in-house or to outsource can have ripples throughout your business
Businesses strive to save money on their Bills of Material (BOMs); each dollar saved on COGS means either a reduced price for the customer or another dollar of profit. Cost-reduction analysis often considers if it’s more lucrative to outsource fabrication or keep it strictly in-house. Both have their advantages and drawbacks and need consideration before making the right decision.
The option that best fits your needs will depend on several requirements:
- Availability and cost labor
- Cost of materials and lead times
- Cost of machinery, including financing and amortization
A binary — but important — decision is whether to bring fabrication in-house rather than outsourcing. Will it provide increased revenue in the short or long-term? Can it be scaled for production if new designs are introduced? What about the indirect costs of doing so? These are just a few questions that we will try to answer to give you a better idea of which process will work best for you.
In-house: The DIY approach
In-house fabrication allows business owners to maintain a high-level of quality control, since fabrication is integrated to within the businesses infrastructure. Not only is there direct control over what’s being fabricated, but it allows for highly-trained individuals to consistently produce a better product. This invariably leads to a lower price-per-product incentive. Some services will no longer be needed, including the shipping/delivery costs associated with outsourcing to a different company.
You will eliminate logistical issues going this route, such as the need for part inspection. In-house manufacturing reduces the need to have your product shipped to you from the manufacturer, implementing some level of quality control and then re-shipping to the end customer. Fabricated parts can be inspected right off the line and then shipped directly from your business.
All efficiency gains go to your bottom line, not to your outsourced manufacturer. Administrative work diminishes over time as processes are refined. This results in a better level of efficiency during the fabrication lifecycle- including and ultimately a greater control over expenses. The ability to adjust the fabrication process whenever needed means rapid response to quality issues, changes in demand or fluctuations in supply chain.
A small sampling of cons is increased costs for skilled labor, higher taxes, insurance and unexpected inventory complications. Some states and jurisdictions in the US require extra inventory to be labeled as added income revenue even though they are raw materials. Doing so adds increased cost overhead, as the materials are taxed as ‘product’. While some admin duties are eliminated, others tend to take their places, such as the need to maintain licensing requirements for certain fabrication machinery (think firearms) or chemicals. Training may also be required to fabricate certain parts, leading to increased expenditures.
Contracting with Others
Outsourcing is a consideration for the same reason in-house manufacturing is considered: cutting costs. Cutting costs associated with labor, materials, and management is possible, but will occur in a different manner. The companies you contract with are now responsible for managing costs. This can save you money in the long-term depending on the amount of product needed and the periods associated with them. Do you need a repetitive standing order on certain fabricated parts produced annually? If this is the case, your savings will come as a bulk discount negotiated up front. The more you need, the more of a discount the fabricators/manufacturers will give you.
Quality control at an external manufacturer can be tailored to your specifications, but that requires very detailed specifications.
Finding a fabricator/manufacturer that’s compatible with your company goals may be time consuming, but is an invaluable resource. Having a trusted partner expands your company capabilities. Additionally, reduced in-house staff and requiring less training for specialists frees up capital. The ability to focus on design and innovation moves your company to a higher margin task. This results in increased revenue in both short and long-term projections.
One of the most prominent downsides is the dependence upon an outside entity: You will depend on a supplier and have to deal with price increases and issues with part quality. You will spend an enormous amount of time on part design and communicating back and forth with a manufacturer. Failure to do so will result in batches of bad parts you can’t use but need to pay for anyway.
The price of logistics needs to be factored in as well, along with cost of missing production deadlines. This is sometimes referred to a ‘your dime their time.’ Cost effectiveness should be calculated with contingencies around paying for any last minute logistical changes or rush shipments. If your margin looks untenable with an occasional overnight shipment charge, you should consider whether you can truly afford to relinquish control.
In a single word: time. You will spend a lot of time waiting for parts or paying to speed up delivery. This can have a large effect on your bottom line.
I have spent years on both sides of the equation, and I have a very simple approach. Until you have a high margin product in a well-defined market, don’t optimize to do all the manufacturing yourself. Yes, you can capture more of the revenue if you take over more of the process. But your time is more expensive than you might think. It’s worthwhile to farm out small jobs to outside entities and deal with the consequences, provided you are working with trusted partners.
There is a lot to be learned from making everything yourself. Just not at the outset of building your product.
This article was originally published on Medium.