Out-Sourced Profits – The Cornerstone of Successful Subcontracting

In business management outsourcing revolves around contracting particular business processes to a third party in an effort to cut costs thus increasing profitability. The article titled Out-Sourced Profits –The Cornerstone of Successful Subcontracting is an analytical report authored by Dr. L. J. Hart-Smith. The article was first presented at the Boeing Third Annual Technical Excellence (TATE) Symposium held at St. Louis, Missouri on the 14th and 15^th of February 2001 serves to offer great insights at to the negative impacts associated with out-sourcing. This paper seeks to provide a well detailed summary of the downside of outsourcing as a business strategy as was witnessed by the Douglas Aircraft Company, a later subsidiary of the Boeing company.

The introduction to this article highlights reasons as to why outsourcing is not a viable means to target lower production costs as these tends to reflect in the overall organizational costs. The first objective stated provides that selective outsourcing may indeed present significant advantages such as supplementing sales though this should be perceived as added costs as opposed to cost production. The author’s other point of discussion is the cost accounting practices that mislead organizations towards outsourcing a major part of their operations. The third goal is to enhance the knowledge organizations ought to have prior employing out-sourcing strategies. The author points out that outsourcing basically increases resources invested in organizational operations thus the need for organizations to focus on in-house operations as opposed to outsourcing. To drive the above stated points home, he focuses on the out-sourcing trends adopted by the now redundant Douglas Aircraft Company which led to its collapse. The subcontractors affiliated to the company on the other hand registered significant growth in profitability. This implies that the outsourced contractors benefit greatly from this business strategy as opposed to the principal organization.

Given that suppliers of outsourced operation are under the same degree from investors to create greater shareholder wealth and the least investments possible, the call of innovation may remain unanswered. Hart-Smith recommends that since large manufacturers such as was Douglas Aircraft Company have a better chance at borrowing funds to continue in-house production rather than outsourcing such operations. Large organizations are in a greater position to source external funds at lesser interest rates as opposed to subcontracted firms. With such funds, an organization can investment in better designed assembly tools minimizing the need for reworked products and thus allow for innovative practices. Considering such eventualities would present lower production costs in the short term as well as in the long-term. There are extra costs associated with outsourced business processes. These include costs attributed to offsite productions such as transportation and communication expenditure, costs associated with omissions, improvements or refinements as well as quality control and assurance costs. These can be minimized with onsite business operations as opposed to outsourcing. In-house business operations not only minimize delays attributed to defective components but also encourage innovative business practices with significant long-term benefits.

Organizations attempt to appraise the benefits of outsourcing by employing Return on Net Assets (RONA) as a performance metric. Hart-Smith provides that this is an erroneous metric to employ as it discourages organizations from optimizing the use of available assets which in itself a negative business practice. This is essentially what transpired at Douglas Aircraft Company leading to unsustainable outsourcing strategies. The RONA ratio presented the organization with performance metrics showing a false scenario that decreasing assets would translate to significant savings.

Hart-Smith strongly argues against excessive outsourcing providing facts that show outsourced suppliers benefiting greatly at the expense of an organization. For instance, if a contract is well formulated, the supplier is able to get a definite profit margin. The supplier also gains rich technical advice from the principal manufacturer in an effort to ensure that the desired quality is realized.  They have no significant risks challenging them and if a major problem was to occur it is highly likely that the principal company may opt to absorb them. It is important o note that the principal organization has to sell the finished product at the prevalent market rate and as such absorbs extra costs associated with over-runs. This implies that the supplier is guaranteed of profitability while the principle organization has to grapple with diminishing profit margins.

The author also provides that large organization prefer not to invest in automation in an effort to cut on costs associated with man-hours. This is due to the fact that underutilization of such in-house facilities proves quite costly. He provides that outsourcing should only be encouraged if the supplier has access to similar or better automation equipment. The now defunct Douglas Aircraft Company sought to maximize out-sourced manufacturing on the false pretence that this would minimize the remainder of assembly work completed in-house. There have been instances where outsourced parts have to undergo remanufacturing not only causing delays but pushing the principal organization to absorb further costs. Out-sourcing the sales component can however provide desirable outcomes if implemented from a comprehensive vantage point. It is important to note that this also eats away on the sales’ profit margin. Organizations thus have to be overly selective in out-sourcing organizational operations.

Outsourcing also present undesirable outcomes as it leads to down-sizing the labor force. This results in diminished motivation as well as company loyalty among blue and white-collar employees. the technical skills lost may be difficult to replace in future.

The author also points out that some organizations often tend to have multiple offsite manufacturing facilities such that there is internal outsourcing. To capitalize on this, organizations have to allocate the right work to other sites with respect to assembly sequence. Minimizing work at the assembly lines cannot be achieved through maximizing production in other sites. The entire process thus has to be programmed to be compatible with the final assembly process. This has successfully employed by the Airbus Company.

Hart-Smith recommends that outsourcing should not be done in an effort to minimize costs only. Perfect efficiency is impossible and attempting to realize this is only counterproductive. The amount of work left at the in-house facilities should be enough to spur innovative development. Outsourcing should only be accorded to suppliers with state of the art equipment. Outsourcing also results in significant production delays. Base cost cutting and saving techniques based on industrial benchmarks as opposed to looking to non related industries. Rather than down size existing labor force, organizations should seek to occupy excess capacity in related ventures so as not to lose irreplaceable skills and manpower. It is important for organizations to seek internal sources of advice as opposed to looking outside of the business as employees have the best interests of the company at heart ads opposed to outside organizations looking to improve profitability from outsourcing contracts.

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