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Today globalization is no longer an option, but a matter of survival for companies. Global manufacturing and supply chain management are two of a company's most important tools when it comes to reducing costs and increasing revenues. Supply chain can be defined as "a set of three or more entities (organizations or individuals) directly involved in the upstream and downstream flows of products, services, finances, and/or information from a source to a customer" (1). To explain this easier we can say that the supply chain is a way to organize the making of a product from the raw material supplier to the finished product which can be sold to consumers. The supply chain consists of three key parts; supply, manufacturing and distribution.
The supply part includes how, when and where the business is going to get their raw materials they can use in the manufacturing. Manufacturing focuses on how to convert the materials to finished products, and the distribution part will try to get these products out to the consumers in the best way possible, through an organized network of distributors, warehouses and retailers. It is important for the company to form out a strategy, so that they take the best advantage of their supply chain. To ensure this, they can use the supply chain management to find the most efficient and cost-effective way.
A business has to take a lot of choices when forming out its supply chain strategy. The management wants to run the business in the most efficient way, so that they can earn the highest profit possible. They have a lot of options on how to organize the supply chain. It can produce its input in-house, it can outsource it in the home country, it can produce them in a foreign country (FDI), or it can import them from a foreign supplier. The biggest multinational enterprises spread their supply chain over many countries which benefits from low average wages and undervalued currency. It is very popular to look at Asia, Mexico or Eastern Europe when you want to outsource your manufacturing because the labor is so cheap in these areas. This may be a much more profitable way to manufacture their products compared to doing all of the production by themselves.
To solve the make or buy problem, the company has to consider a couple of factors regarding an outsourcing-strategy. First of all they have to see if outsourcing the parts really would reduce the manufacturing costs. That's often the most obvious reason to choose an outsourcing strategy. To achieve a complete overview of all the costs associated with outsourcing to another country, they can make a total cost analysis. Labor costs may be such a small part of the total costs, that it will not necessarily be profitable for the business. They also have to take into account all costs related to for instance transportation and storing.
They also need to find a manufacturer they can depend on when it comes to products and price. In the same category we can put the importance of quality. They have to be sure that the products and services are of high quality, and that the speed of the delivery is acceptable. It is important that the finished products reach the market in time.
A famous saying is: "do what you do best and outsource the rest", and many firms live by this rule. It means that you need to find your core competence, which means the areas that make the firm unique, and where they may have a competitive advantage. Burt, Dobler and Starling (world class supply management (1) present a rule of thumb for outsourcing. According to them a firm should outsource all items unless it is critical to the success of the product, it requires specialized design, skills or equipment and there are only a few reliable suppliers, or if it is within the core competence of the business. If the item fits at least one of these characteristics, it should be produced in-house. Another thought is that you should outsource if it gives you better value for money compared to producing it in-house.
There are of course many pros and cons by both in-house manufacturing and outsourcing. We will start by mention the most important advantages of outsourcing compared to making the part in-house.
The primary and most common motivation to why businesses outsource parts of their manufacturing is the opportunity to save money. It is a well known truth that people in developing countries are paid far less than people in the West. U.S Bureau of Labor Statistics estimate that the average wage in China is 67 cents an hour. This is a number significantly lower than the average of 23, 65$ earned by US factory workers. Because of these conditions China has become the most popular country for companies to source out their manufacturing, and Wall Street Journal have described it as "the world's factory floor".(1)
Other cost saving benefits in addition to lower salaries is that for every employee you can cut off, you can save costs and maintenance of for example a computer and you can cut expenditures and time related to training of new employees. You might also save money connected to research and development (R&D), marketing and launching.
Another great advantage by outsourcing is that the subcontractor most likely is an expert in the service they provide, and it is their core competence. This means that the business is receiving a higher quality service than they would get with an in-house employee. The service provider also has a reputation to take care of, and if they don't deliver the quality that is expected, the competition is very high so they might be replaced by another subcontractor. If you are a relatively small firm you may not have enough capital to obtain the best technology, than you can take advantage of the subcontractors technology since that is part of their core business.
When you choose to outsource your manufacturing business you get the opportunity to really focus on your core competence, and can develop this to a new level.This will give you an even bigger competitive advantage.
A pro regarding outsourcing can also be that it is risk reducing and flexible. Changes in the environment such as market and technology can happen really fast, and it can be difficult to keep up with these changes. When a company outsource, the risks are divided between several different companies. A specialized supplier invests not only for one firm, but on the behalf of all clients. By sharing these investments, the risk reduces for each business. It is also more flexible because it is much easier to cut a supplier, than to tell an employee that he is fired.
In some cases the fact that you have a "specialist" in your company, which normally will increase the quality and lower the costs, may be a factor that attracts customers.
There are also a couple of disadvantages connected to outsourcing.
There is of course always a risk that you don't earn the profit you expected by the outsource investment. When you manufacture a component in-house you know what you get, but outsourcing is a way more insecure strategy
Another disadvantage is that you will lose managerial control. When you subcontract your manufacturing you give the management and control to this company. The company you outsource to will have no connection to your business beyond the contract, and will not be driven by the same standards and guidelines as your company. You don't have the same quality control when outsourcing opposed to manufacturing in-house.
Outsourcing may threat and upset your employees, and make them feel less important. This can affect the quality of their work. It is important to always keep your employees motivated. Employees are often far more loyal to their company, but the supplier will not feel the same connection. They often have a lot of customers and are motivated by profit. You may risk that they only want the job done, and that the quality of the job isn't as good as it should be.
When you manufacture in-house you can find out when the products isn't of acceptable quality, and you still got the time to do something. When your outsourcing to a foreign supplier your extremely vulnerable that your products reaches the market in time. The products may be transported to the market just before the deadline, and if the quality isn't good enough it's too late to send them back. This can make you lose your customers.
Another option that has become an increasing trend the last decades are foreign direct investments (FDI). FDI can be defined as "any form of investments in enterprises which function outside of the domestic territory of the investor" (1. There are several opportunities to how you can get into a foreign market by a FDI including franchising, joint ventures