Outsourcing decision should be driven by outsourcee profitability analysis.

categories: misc

Outsourcing decision should be driven by outsourcee profitability analysis.

Idea : it makes sense if the cost saving for the outsourcer is higher than the benefit outsourcee is expected to provide to its share holders.

Why suggestion this definition: the outsourcee has to return some of the profits to share holders thus, lower cost implies that the efficiency gains brought by external operation have to be higher than the industry average P/E.

Proposed result: on topics where the industry has reached plateau and minor efficiency differences exist between players, internalising the function might actually allow systematic cost savings.

In other words:

Cost_internal/unit -cost_external/unit > profit_external/unit

So it is not enough to suppose that

Since cost_internal/ unit > cost _external/unit outsourcing will be beneficial !

Areas where it is likely to be true are when fixed cost have a high ratio of the total cost (dedicated factory, …) or if the internal usage ratio of a ressource is not close to 100%.

Areas where fixed costs are a low % might seem at first beneficial but they will mostly reduce cost by reducing quality. This will in time destroy value in the long run for both outsourcer and outsourcee.