Every original equipment manufacturer (OEM) has many things to consider, but one of the most important issues is the outsourcing of work. When considering a reliable contract partner to do the work, an OEM may overlook a number of factors, especially indirect costs.
Long before it considers outsourcing, your company needs to evaluate the true costs involved in manufacturing. A proper understanding of this issue will be needed when comparing the services of different contract manufacturers and before selecting the firm that has the most to offer. A careful comparison will be necessary if you want to do what is best for your business.
An OEM will often contrast the expenses related to labor and manufacturing with the total cost of outsourcing with a partner. In order to obtain an accurate assessment of the cost of manufacturing a piece of equipment or any product, however, it is necessary to consider more than merely your material bill and your labor expenses.
Calculating Indirect Costs
The calculation of such costs does not take into consideration indirect overhead expenses, which can be both fixed or variable. A valid comparison between the costs of in-house versus outsourced production will require the calculation of many other factors, including the follow:
- Production floor space
- Production facility utility needs, including electricity, natural gas, water and sewer services
- Production equipment costs
- Production equipment depreciation
- Production equipment maintenance personnel and outside repair services
- Production floor janitorial services
- Factory management personnel
- Factory floor record-keeping personnel
- Factory equipment setup personnel
- Accounting department personnel
- IT personnel for computer and communications systems used in the manufacturing process
- Handling personnel, such as forklift operators
- Inspection department personnel
- Purchasing department personnel
- Receiving department personnel
- Inventory and inventory control
- Supplies for production equipment
- Miscellaneous material expenses
- Environmental costs
- Safety costs
- Insurance coverage for the equipment and the facility itself
- Other general and administrative costs
Your Most Important Expense
Manufacturing and related costs pale in comparison with opportunity expenses. When your company is preoccupied with secondary products and issues, it will hamper your ability to provide your customers with the latest products in a timely manner.
The next time you compare the costs of producing in-house or outsourcing the work, you need to consider the opportunity costs that might not appear on your balance sheet. Only then will you truly be able to decide on the best solution to your manufacturing needs.
An Outsourced Production Case Study
The following is an example of how outsourcing reduced the indirect costs of a particular OEM, with a list of some of the promising business opportunities it was able to reach:
- The contractor received a single order for 300 units of a certain product, relieving the OEM from having to take any other steps.
- The procurement and receiving departments purchased and processed 141,600 parts from 52 outside firms over a period of five weeks, during this time managing orders with the suppliers of commercial and electrical components, raw materials and sheet metal, and with a plastic injection molding company.
- The contractor’s machine shop managed 1,837 computer-controlled machining hours to manufacture 10,500 parts over the same five-week period.
- The assembly department managed 4,277 assembly hours to produce 300 ordered units over a period of nine weeks.
- The production crew was comprised of five electrical assemblers, four mechanical assemblers and a quality control inspector.
Throughout the entire process, the OEM was freed from having to deal with any of these specific issues or having to calculate any of the indirect costs involved. Additionally, it did not sacrifice a single opportunity due to inside or outside distractions.
The next time your OEM decides to outsource its manufacturing work, the company will have to calculate its indirect in-house costs before it can finalize a contract with another firm. Once you have determined your own production costs, you will be able to decide which partner can best serve your company.