Has outsourcing gone too far?

Citation metadata

Publisher: McKinsey & Company, Inc.
Document Type: Article
Length: 4,228 words

Document controls

Main content

Article Preview :

Farming out in-house operations has become a religion.

Faith must now be tempered by reason.

If all manufacturers sang from the same hymnal--and many do--they would outsource almost everything: management gospel holds that manufacturing is too labor -- and capital-intensive to support the high margins and fast growth that investors demand. By shedding assets, companies can be born again as product designers, solutions providers, industry innovators, or supply chain integrators-and, it is said, quickly boost their return on invested capital. Indeed, Standard & Poor's reports that in the year 2000, the market-to-book ratio of the S&P 500 was six times greater than it had been in 1981--a reflection of the declining importance of tangible assets.

Such pressures and perceptions make outsourcing an almost irresistible impulse for manufacturers. Global access to vendors, falling interaction costs, and improved information technologies and communications links are giving manufacturers unprecedented choice in structuring their businesses. Through outsourcing, companies can now dump operational headaches and bottlenecks downstream, often capture immediate cost savings, and avoid labor conflicts and management deficiencies. We are aware of no managers who have been taken to task for farming Out in-house operations.

But in the race to hand over capital-intensive manufacturing assets to outside suppliers, companies may be ceding the very skills and processes that have distinguished them in the marketplace. Consider the case of Gibson Greetings, the oldest US greeting-card maker. In the 1990s, it started running out of cash. To realize savings, Gibson chose to outsource its manufacturing, but it soon ran into supplier-management problems that cost the company its place at large retailers. In the meantime, its competitors had been investing in more efficient printing and production technologies. Ultimately, one of those competitors acquired Gibson. An analyst observed, "The final nail in the coffin was that Gibson got out of the manufacturing business and started outsourcing." [1]

Obviously, the decision to outsource usually doesn't produce such a drastic outcome; done right, outsourcing manufacturing or services can deliver game-changing levels of value. But by assuming that outsourcing is the answer rather than critically assessing its pros and cons, companies may be failing to do what really matters: improving a company's performance and maximizing value. Outsourcing can be instrumental in realizing these goals--but not always.

We are not suggesting a return to the time when Ford's River Rouge complex made its own glass, steel, and tires; an original-equipment manufacturer facing the complexities and asset intensiveness of that level of vertical integration would now collapse under its own weight. Indeed, about two-thirds of the North American auto industry's $750 billion in value now resides with suppliers. This year, the average electronics OEM was hoping to outsource 73 percent of its manufacturing, according to Bear Stearns, and 40 percent of all OEMs were hoping to outsource the manufacture of 90 percent or more of their final product. [2] Pharmaceuticals companies have been witnessing the emergence of a $30 billion contract drug-development and - manufacturing market with annual growth rates of 17 to 20...

Source Citation

Source Citation   

Gale Document Number: GALE|A80118054