Has outsourcing gone too far

Abstract

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 SP 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 percent. [3] In general, the outsourcing of operations and facilities across industries rose by 18 percent in the period from 1999 to 2000. [4] Yet the rush to outsource has delivered much less value than it might have. A McKinsey study indicates that more effective outsourcing, which requires a better process for identifying and managing the natural owner of every activity in the value chain, could by itself almost double the auto industry's total profits. But so far, most of the supply networks of the automakers have been notable less for capturing a larger share of the total value for themselves than for imposing punitive (and ultimately unsustainable) terms on suppliers (see sidebar, Biting the hand that feeds you, on the next page). …

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