It is interesting how many companies make wrong decision when evaluating insourcing vs outsourcing options. Let me provide one example that may be typical.
Let’s assume I have a factory in the US and an affiliate in any other country that manufactures the same product as I do, but is also vertically integrated into one component and manufactures it in-house. When the US affiliate has to decide if they want to buy that component from an external supplier or from the affiliate they compare the final landed cost for that product.
A simplified analysis would look like this:
Let’s assume I have a factory in the US and an affiliate in any other country that manufactures the same product as I do, but is also vertically integrated into one component and manufactures it in-house. When the US affiliate has to decide if they want to buy that component from an external supplier or from the affiliate they compare the final landed cost for that product.
A simplified analysis would look like this:
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Here, the obvious decision is to buy from the external source, but this lies under a wrong assumption as the in-house analysis doesn’t consider incremental costs. Variable costs are not always really variable. If the in-house factory is running with free capacity then adding this new volume to the factory may, for example, not necessary require additional Headcount.
If we assume that this new volume won’t require additional headcount, a different analysis based on incremental costs would look like this:
The theory of constraint (see The Goal by Goldratt) recommends assigning the whole cost to the constraint. If some element in your process or system is not a constraint, then the cost for it is equal to cero.
