Any company that is contemplating reshoring their contract manufacturing should also consider whether it would make more sense to produce their components or products in-house.
This decision, commonly referred to as the “make-or-buy decision”, will depend upon a variety of factors. These factors should include the company’s core competencies, the product’s maturity and criticality, the volatility of the product’s demand, and whether or not the contractor can produce the items better and cheaper.
In the post COVID era, another key criterion should be the dependability of the contractor. Any contractor under consideration must have an agile production infrastructure which can easily respond to changes in product requirements and order volumes.
In addition, they should have resiliency plans in place to respond to disruptive events, whether internal or in response to the buyer. The contractor must ultimately be able to achieve these characteristics more economically than the buyer.
Choosing the Product to Outsource
While the decision to consider contract manufacturing depends on many factors, they can all be surmised in one word – risk.
Products that fall into the high-risk category are typically those that are of high-value or are brand-new, either with high or low demand volatility. Such products will likely serve as candidates for in-house production. Lower value products with high but stable demand that require high labor effort are better suited for outsourcing.
To guard against uncertainty in demand, firms typically produce less volume in-house to avoid overproducing. However, by doing so, they risk not being able to fulfill their production requirements. In this scenario, they would benefit by outsourcing their work to an agile and responsive contractor.
Contract manufacturers are use to working with a multiplicity of products and buyers and have mastered the integration of both product and process focused operations. A responsive contractor can simultaneously operate multiple production lines for different clients, often at a lower cost. Such contractors provide value by absorbing uncertainty (at a committed unit price) and eliminating the buyers risk of not completely fulfilling often fluctuating production requirements.
Consider a buyer who needs to fulfill an uncertain demand requirement to package, seal, and case pack tins of a particular product. Finding a contract manufacturer who can produce a fixed volume at a fixed price, say 2 million units at a unit price of $1 would be an attractive option. If the buyer were to attempt to satisfy this demand on their own at unit costs equivalent or above this price (which will likely be the case), the contract manufacturer would still provide savings over a wide range of volumes.
To analyze this situation, we developed a computational model1 to estimate the cost savings of having a lower cost manufacturer producing a volume of an item, versus the buyer producing the same volume on their own.
Our model showed that outsourcing provides savings from 3-30% over volumes ranging from 500 thousand to 2.5 million units – enabling the buyer to respond to fluctuating demand. The exact savings would depend on the level of volume and the buyer’s own unit cost percent increase. Firms might be driven to insource when volumes are high and demand variability (or uncertainty) is high, but they run the risk of overproducing or being short of product.
A Matter of Choice
In this post-COVID era, companies are contemplating insourcing versus outsourcing to contract manufacturers in attempts to near or on shore production. Assuming that it would be simply cheaper and safer to produce items in house places the firm at risk, for the very reasons described above.
Transferring risk to a responsive, agile, and lower cost contract manufacturer can better hedge against uncertainties surrounding product demand. Our example demonstrated that such an option can robustly provide added value to a buyer.
While cost is typically a determining factor when choosing a supplier, it should not be the sole criteria. Quality and reliability are two necessary characteristics that assure a supplier’s ability to unfailingly fulfill the product’s volume requirements, otherwise they would provide additional unwanted risk. Altogether, utilizing a dependable contract manufacturer serves as an insurance policy for successful fulfillment.
Matthew Liotine, Ph.D.
Vice President, BLR Research
Professor, University of Illinois at Chicago
Many types of companies have a need to assemble their products, whether a manufacturer that requires the assembly of components for further manufacturing processes or a retailer that must assemble products to make themselves ready for display. Companies that require product assembly must either perform these services in-house or outsource to a contract assembly provider. Outsourcing can be very beneficial to companies, although they should be aware of the advantages and disadvantages of contract assembly.