Cost of unplanned and unforeseen risks. Organizations that outsource production tend to overvalue the labor savings they expect to gain from outsourcing and undervalue all the other potential costs and risks. These include such underhanded practices as intellectual property theft, and product and component piracy and theft that may be acceptable or are rarely (if ever) prosecuted in some countries where outsourcing is common. In fact, the risk of unauthorized copying of products increases when outsourced manufacturing is involved. One of our clients, for instance, discovered that a supplier was selling the client's parts and components to a family member, who then reproduced the branded product and was selling it for US $600 less than the originals. This kind of product piracy can generate additional hidden costs, such as warranties and repairs that the legitimate company may end up paying for.
In addition to "man-made" risk, unpredictable situations like tsunamis, earthquakes, and other natural disasters add irreversible costs to the outsourcing process. It's imperative, therefore, that responses or contingency plans for dealing with all of the possible risks and potential consequences be integrated into any outsourcing strategy. This will allow you to mitigate the costs of those consequences and recover more quickly.
Uncover hidden costs
It is no secret that most decisions to outsource production were fueled by the expectation of huge labor savings. But the largest cost driver in many products today is materials, not labor—so chasing labor savings is yesterday's game. Still, some executives are reluctant to revisit their past decisions. This is unwise, because complacency, postponement, or procrastination about improving outsourcing costs are not winning strategies for future success.
In fact, there is a lot of "gold" to be found in the outsourcing practices of most organizations, but it's not easy to uncover these hidden costs. Because outsourced production involves a complex network of transactional processes, it obscures a significant array of costs. Complicating matters is the fact that outsourcing involves a lot of unpredictability, professional judgments versus hard data, a high degree of informal activities underlying a formal process, and fuzzy cause-and-effect situations. For the uninitiated, or for those who are too hasty, it is easy to double-count or totally miss these elements of costs, thus quickly compromising both the reconciliation of the numbers and the credibility of the analysis. Given those conditions, the path to reducing outsourcing costs is to redefine and employ a combination of seasoned experience with the best data-driven and evidence-based strategies in today's global marketplace. Some of the most effective tools include activity-based cost analysis and using an organization's integrated enterprise architecture and other information technology resources to trace transaction streams and reconstruct these hidden costs.
Most companies need to improve how they make their outsourcing decisions, not because they made a mistake but because outsourcing is a dynamic process where circumstances change over time. And in fact the situations surrounding the 10 hidden costs described in this article can be game changers, because they may open the basic assumptions underlying outsourcing decisions to question and make a different option more feasible and cost effective. It is more than worthwhile to re-evaluate outsourcing of production now. A serious effort at improving the outsourcing decision-making process can easily add a few more margin points and millions of dollars in new savings opportunities.