Bringing outsourced work in house is very profitable!

The mantra from many consultants and business advisers is to improve profitability by outsourcing or off-shoring. The justification for these recommendations and decisions is based on comparison of the internal cost and purchased cost. The internal cost is based on some form of cost accounting – which usually absorbs overheads into the processes – this includes Activity Based Costing. Many times the “apparent” cost advantage of outsourcing work can be lost in quality, logistic and lead time issues. The flaw lies in the way the internal costs are calculated. Once a decision is made it often stays in place without a common-sense review.

How do we know whether to bring outsourced work back in house?

First you need to understand if you have the capability to bring the work back in house. For example – if the outsourced work is something like electro-plating and you do not have such capability in house – then you need to accept the situation. However, if you do have the capability – then you need to consider if you have the capacity. If the work would need to be done by an internal bottleneck resource - then you need to accept the situation until additional capacity is revealed. However, if the work would need to be done by a non-bottleneck – then you do have some capacity.

The next question is – is it worthwhile – but let’s examine this under Throughput Accounting.  On the basis that you already have capacity then the additional cost is only the TVC – totally variable cost – usually only the cost of material. If this is compared to what you are paying now – which must include the same material, operating expense and a profit margin – it will be clear that bringing the outsourced work back in house can be very profitable.

Also bear in mind that often – when the components were first obtained from outside – a high price is paid - based on small quantities/non-repeating work. Over time the quantities increase – but often the purchase price is not fully reviewed – especially when the component is not a significant part of the finished product.