The Hidden Costs of Outsourcing

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Coordinating contractors or vendors can cost a firm anywhere from 0.2 – 2 percent in addition to the annual cost of the deal. The costs associated with this includes document requirements, sending out request for proposals and evaluating the responses and negotiating a contract. Firms may have a project leader that could be working full time on this along with the help of others. This whole process can take from six months to a year depending on the type of relationship needing to be secured. This is a step that most firms do not want to rush as there is a lot of money involved in this process. The consequences of rushing such a huge step in the global outsourcing process could mean huge problems for the firm like weak local leadership, poor direction of the outsourcing supplier by the buyer, or bad supplier selection. Firms must collect and analyze data overtime and ask questions as to why something happened until the problem can be defined.

Cost of Subpar Inventory Performance

When a firm outsources their manufacturing, it reduces the firm’s flexibility in design and the ability to respond to schedule changes. As a result, more inventory may be produced than needed and there may also be mismatches between supply and demand, increases in variances from inventory checks, or even obsolete inventory. When inventory is not abundant, it requires the firm to sell what is currently in its warehouses to meet their quotas and potentially cause them to lose consumers as products may be on backorder and the consumer can potentially go to a competitor and purchase the products needed from them. Inventory issues can lead up to 10 percent of total revenues and in some cases it could potentially be a greater loss. Constant attention to the changing markets and the use of a more segmented demand-chain strategy can help firms cut their costs of inventory performance.

Cost of Unplanned Logistics Activities and Premium Freight

When companies outsource, it reduces flexibility and makes it much more difficult to be responsive to the changes in the consumer’s requirements. It also increases the distance between the entry of the order and the final fulfillment. When a company has poor planning and oversight with demand and supply chains, it leads to expenses that are considered unnecessary. Too many hands are involved and creates a time management issue on getting the product to the consumer quickly. When this issue arises, most companies can expect to spend more by sending the product by air to get it to the consumer on time. To prevent this issue, companies need to think through their planning and have better control over their deliveries of the outsourced products.

Cost of Inappropriate Sales and Operations Planning

There are significant costs associated with the sales and operations planning when it comes to outsourced production. When considering the fulfillment process of goods, any schedule changes potentially have a much larger impact than what they did in the past. Before outsourcing was available, a manager could easily walk into the plant or drive to meet the supplier to see what was going on and make adjustments as needed. Now that the production process could be several hundred miles away, this is a much more difficult task to do and creates complexity issues when there is more than one demand stream.

Cost of Poor Substandard Quality

When a firm does not take into consideration the total costs of inadequate quality there is a chance of 5-12 percent of the revenues lost. Depending on how conscious or unconscious a firm is it could go up to as much as 20 percent of the firm’s revenues. However, it is often very difficult to quantify quality-related costs, which is an indicator as exactly how hidden these costs truly are. The obvious ones like scrap, rework, and repair can be justified by the financial statements, it’s the prevention, detection, internal failure, and external failure that are more difficult to identify. The quality standards that are difficult to identify require making assumptions and employing an activity-based management approach to classify real and hidden costs associated with poor quality. The best way a firm can deal with these costs is to undergo a proactive prevention rather than deal with them after they have occurred.

Cost of Warranty, Returns, and Allowances

When a firm does not produce a product that meets its quality standards, then the chances of the consumer using the warranty or returning the product goes up. When a consumer uses a warranty, the firm then needs to repair or potentially replace the product to keep the consumer satisfied. On the other hand, if a consumer is not satisfied with the product, the firm chances losing the sale by the consumer returning the product back to the store. Firms will also do allowances for products that have minor blemishes but are fully functional, but still causes issues with revenue as the product is discounted a little. For most firms, covering the costs associated with warranties, returns and allowances has become a way of conducting business. Most firms set aside money that they think will be spent on these costs each year. However, this does not address the source of the problem, which could be traced and fixed through the right processes if the company would set the time aside to figure it out. When a firm is capable of figuring the problem out through early identification, the costs associated with warranty issues can be avoided before it becomes a huge problem.

Cost of Supplier Management

When you look at everything that goes into supplier management, the costs can easily add up. Selecting, developing, maintaining and making sure a supplier continues to perform at the expected levels require a lot of time from managers, which in turn requires a firm to spend more money to make sure that everything is going smoothly. Another issue with supplier management comes in the form of products that are to be designed using the lowest-unit-cost design metric. This could potentially cause a firm to select cheap and substandard suppliers to keep their costs lower. The firm is forgoing the quality that it could and should put in towards the product to make sure it meets the consumer’s standards. The poor choice in suppliers for cheaper materials can result in a loss of the firm’s consumers which has an impact on the company’s revenues. Not only will the firm lose consumers due to this issue, the potential to gain new consumers is relatively low too. Firms can avoid some of the costs associated with supplier management