Outsource Manufacturing: How It Works, Examples, Advantages, and Disadvantages
Outsource manufacturing is a business strategy wherein companies delegate the production of goods or components to external parties, rather than handling it in-house. This approach has become a go-to strategy for various industries, offering advantages such as cost savings and access to specialized expertise.
In this article, we will discuss the mechanics of outsource manufacturing, give examples, and evaluate its advantages and disadvantages.
Outsourced manufacturing, also known as contract manufacturing, refers to the practice of hiring a third-party company to produce goods on behalf of another company. This can be done either within a country’s borders or internationally, which can help businesses save both time and money. Businesses that outsource can stay competitive by only focusing on their core competencies.
The main reason many companies choose to outsource manufacturing is to reduce the costs and time it takes to produce certain products. A large facility with many resources can usually produce a part a lot cheaper and faster than a smaller company can on its own. Outsourcing manufacturing not only allows for reduced labor costs on the floor, it also allows companies to cut back on: HR resources, management time, overtime pay, sick and holiday pay, training, and other labor-related costs. It also allows companies to seamlessly up or downscale production.
Outsourcing manufacturing is really important for companies, especially small companies because it can help save money by tapping into lower production and labor costs. This frees up the company to focus on what it's best at—things like designing special products and effective marketing. The scalability of outsourcing permits easy adjustments to production levels based on demand, without substantial capital investments. Access to specialized expertise from contract manufacturers can enhance product quality and improve manufacturing processes. Global reach is also expanded. Companies can enter new markets and take advantage of favorable economic conditions around the world. There's a risk reduction aspect, too. By sharing the manufacturing load, a company becomes more resilient to things like changes in the market and supply-chain hiccups. Environmental and regulatory compliance benefits are relevant, too—outsourcing partners are likely to already have addressed such issues. Also, outsourcing manufacturing helps companies avoid the costs of upgrading and maintaining equipment—this is the responsibility of the manufacturing partner.
Outsourcing in manufacturing can have a profound impact on a country's economy, particularly in terms of job displacement. While the debate on whether outsourcing causes net job loss or job creation continues, it's undeniable that certain types of jobs are eliminated.
In the case of manufacturing in the United States, a lot of the traditional jobs, like those involving repetitive manual work, have either gone to countries with cheaper labor or been taken over by technology. Now, US factory jobs are more about information technology, robotics, precision machines, and engineering. This shift has hit some towns hard, especially in regions like the Northeast, Mid-Atlantic, and Midwest, giving rise to what's called the "Rust Belt." This term reflects the economic decline, population drop, and decay in cities caused mainly by the collapse of the domestic industrial sector. While some argue that this change might bring in more high-skilled jobs, the immediate impact on communities can be tough. So, the effects of outsourcing on a country's economy involve a mix of job changes, economic shifts, and the need for strategies to deal with the downsides.
Manufacturing outsourcing works by a company contracting another entity, often a specialized manufacturer, to produce goods on its behalf. The outsourcing process typically begins with the hiring company providing the outsourcing partner with detailed product specifications, designs, and sometimes raw materials. The outsourcing partner then takes on the responsibility of the actual manufacturing process, utilizing their expertise, facilities, and workforce. Effective communication between the hiring company and the outsourcing partner is crucial throughout the production cycle to ensure that the final products meet quality standards and specifications. The outsourcing arrangement may cover various stages of the manufacturing process, from the production of components to the assembly of finished goods. This approach allows the hiring company to leverage the outsourcing partner's specialized skills, reduce production costs, and often benefit from the partner's advanced technologies and efficient processes.
Outsource manufacturing differs from other types of outsourcing in that it specifically involves contracting a third-party entity to handle the production of physical goods. Unlike outsourcing services or business processes, manufacturing outsourcing focuses on the creation of tangible products. In this arrangement, the hiring company typically provides product designs, specifications, and sometimes raw materials to the outsourcing partner, which then manages the actual manufacturing process. This form of outsourcing is typically applicable to industries like: electronics, automotive, and consumer goods. In contrast, other types of outsourcing may involve services such as: customer support, IT, or business process outsourcing, in which the emphasis is on outsourcing specific tasks or functions rather than the physical production of goods.
It can be. It depends on where the outsourcing partner is located. Manufacturing offshoring outsourcing involves the outsourcing of production to a company in another country. However, when a company outsources to a third party in its own country (onshoring), also called domestic outsourcing, or to a neighboring country (nearshoring) this is not considered offshore outsourcing.
To learn more, see our guide on What is Offshoring.
To outsource manufacturing effectively, follow these key steps:
- Assess when outsourcing makes sense for your company. It's typically beneficial when it reduces costs or transforms fixed costs into variable costs. Identify activities for which external suppliers have competitive advantages or expertise.
- Choose a manufacturing partner carefully. Consider factors such as: technical capabilities, capacity, facilities, and systems. Ensure they are financially stable, have robust quality systems, and can consistently meet specifications and schedules.
- Assess the manufacturer's technical capabilities, willingness to adapt to your requirements, financial stability, and ability to consistently meet specifications and schedules. Establish clear communication channels for project success.
- Develop a detailed Request for Proposal (RFP) to define project objectives and requirements. Clearly convey project information and ask relevant questions to ensure a mutual understanding between you and potential manufacturers.
- Focus on design for manufacturing to streamline the production process. Review material specifications and dimensional drawings and ensure a balance between high quality and low total cost.
- Integrate quality assurance (QA) throughout the production process to prevent defects and ensure quality requirements are met. QA is crucial at every step, from manufacturer selection to materials selection and production.
- Prioritize effective communication. Establish a system for project communications management to ensure timely and appropriate information exchange. Open and candid communication is crucial for successful project management.
Outsource manufacturing can be a strategic business approach, and should be considered in the following scenarios:
- When the primary objective is to reduce production costs significantly. This is often achieved by leveraging lower-cost locations or taking advantage of specialized expertise offered by external partners.
- If driven by the desire for operational efficiency and cost-effectiveness. When outsourcing, companies prioritize tasks in which external suppliers have a competitive edge, be it in conceptual design or final product production. The key factors are speed and affordability. If external partners can complete a part of the production process faster or at a lower cost without compromising quality, it makes practical sense to outsource that specific task. This approach allows businesses to focus on their strengths while benefiting from the specialized skills and efficiencies of external collaborators.
- If external suppliers have competitive advantages in certain aspects of the production line, outsourcing becomes a viable option. This is particularly relevant when other suppliers can perform activities more efficiently or economically.
- Enables companies to concentrate on their core competencies. By delegating manufacturing responsibilities to external partners, businesses can redirect their efforts toward things like: innovation, design, and marketing.
- When a company does not have access to certain resources or does not have the relevant equipment available in-house. Outsourcing to partners with access to resources and equipment can eliminate this gap.
- If businesses do not have access to the relevant skills through employees who are part of the company. Outsourcing to a partner with the relevant skills eliminates the need to recruit new staff or train the staff on hand.
There’s no fixed amount that companies will save on manufacturing outsourcing since it will rely heavily on: the type of industry, amount of products, production size, etc. However, according to the International Organization for Standardization (ISO) and the Harvard Business Review, on average, businesses can expect cost savings ranging from 15% to 30% when opting for outsourcing compared to in-house production. This estimate is influenced by several key cost factors. Labor costs play a key role, with outsourcing destinations often chosen for their lower wage levels. Overhead expenses, including facility and utility costs in the outsourcing location, are also key contributors. Material costs are influenced by the availability and pricing of raw materials in the outsourcing destination. The technological landscape and equipment capabilities in the outsourcing partner's location can also impact costs, with advanced technology potentially offsetting higher upfront expenses. Customization and the complexity of manufacturing processes, as well as the volume of production, logistics, transportation, and adherence to quality standards, further contribute to the overall cost considerations.
Yes, manufacturing outsourcing can be a good strategy, however, it’s not a one-size-fits-all strategy or universally easy. Businesses should first consider different factors, such as: cost savings, transportation challenges, lead time, business goals, import costs (for offshore outsourcing), etc. When all of these factors have been taken into account and the decision still makes sense for the business, then yes, manufacturing outsourcing is a good business strategy for the particular business.
Several industries leverage outsourced manufacturing to streamline their production processes and enhance efficiency. Here are examples of industries that commonly engage in outsourcing manufacturing:
Construction outsourcing involves hiring external companies to produce components or carry out specific tasks in construction projects. The hiring companies often outsource the manufacturing of components such as pre-fabricated building materials, windows, and doors to specialized manufacturers. They can also outsource tasks such as: precast concrete fabrication, steel component manufacturing, or even entire building modules. For example, a construction company might outsource the fabrication of steel girders for a large-scale commercial building.
This allows construction firms to focus on project management and design. This can speed up construction, enhance quality, and reduce labor costs. The cost varies depending on the scope of outsourcing, and it may include negotiation for custom manufacturing. Outsourcing in construction can lead to faster project completion, cost savings, and improved quality control, especially when working with specialized manufacturers.
An example of a construction company that utilizes outsourcing is Turner Construction. Turner Construction often outsources the fabrication of specialized building components, such as steel structures or precast concrete elements. By doing so, Turner can streamline its construction projects, enhance the quality of the structures, and focus on effective project management and design.
Medical outsourcing involves contracting external manufacturers for the production of medical devices, equipment, or even pharmaceuticals. Outsourcing can cover anything from the precision machining of medical components to the production of sterile packaging for medical devices. Medical companies often partner with specialized manufacturers to leverage their expertise and facilities, ensuring compliance with stringent industry regulations. The cost of these products can vary based on: the complexity of the product, materials used, the type of product, the amount being produced, and regulatory requirements.
Outsourcing in the medical industry can lead to faster time-to-market, reduced production costs, and access to advanced manufacturing technologies. Outsourcing medical equipment and products to external service providers allows the medical industry and staff to focus on key competencies, like patient care.
Medtronic is an example of a medical company that engages in outsourcing for various aspects of its medical device production. This allows Medtronic to benefit from the expertise and facilities of these external partners, ensuring compliance with rigorous industry regulations and speeding up the time-to-market for their medical devices.
Marine outsourcing involves subcontracting the manufacturing of marine components such as: engines, navigation systems, or even entire vessels. Collaboration with specialized manufacturers ensures that marine companies can benefit from their expertise in areas such as: shipbuilding, engine manufacturing, or electronics. For example, Brunswick Corporation, a leader in the marine industry, can outsource the manufacturing of marine components. The cost depends on the complexity of the marine components being outsourced, including materials, labor, etc. Outsourcing in the marine industry can lead to cost savings, improved product quality, and faster production cycles.
Electronics outsourcing involves contracting external manufacturers for the production of electronic components, circuit boards, or even entire devices. For instance, a tech company might outsource the production of circuit boards for a new smartphone model. Electronics companies partner with manufacturers to take advantage of specialized facilities, equipment, and expertise in mass production. Outsourcing in the electronics industry can lead to: cost savings, faster time-to-market, and access to the latest manufacturing technologies.
Apple Inc. is a good example of a company that makes use of electronics outsourcing. Apple outsources the manufacturing of its electronic devices, including iPhones, to contract manufacturers like Foxconn.
Pharmaceutical outsourcing involves contracting external manufacturers for the production of pharmaceutical drugs, APIs (Active Pharmaceutical Ingredients), or packaging. Outsourcing in the pharmaceutical industry can cover various stages of drug development, from research to production and packaging. Pharmaceutical companies collaborate with external manufacturers to benefit from their expertise, compliance with regulatory standards, and production capabilities. For example, AstraZeneca, a global pharmaceutical company, outsources the production of certain pharmaceutical drugs or APIs to specialized contract manufacturing organizations (CMOs).
Outsourcing in the pharmaceutical industry can lead to cost savings, faster drug development, and increased flexibility in responding to market demands.
Automotive outsourcing involves contracting external manufacturers for the production of automotive components, subassemblies, or even entire vehicles. Outsourcing can include tasks like: metal stamping, engine manufacturing, or the production of electronic components for vehicles. Automotive companies partner with these manufacturers to benefit from their efficiency, expertise, advanced manufacturing capabilities, or even access to their machinery. Outsourcing in the automotive industry can lead to: cost savings, faster production cycles, access to resources and skilled labor, and the ability to focus on innovation and design.
Tesla is an example of an automotive company that outsources the production of specific vehicle parts, such as batteries or electronic components, to specialized manufacturers.
Aerospace outsourcing involves subcontracting the manufacturing of aerospace components, aircraft parts, or entire aerospace systems. Boeing, a major aerospace company, is an example of outsourced manufacturing in the aerospace industry. Boeing collaborates with external manufacturers for precision machining, composite material manufacturing, or avionics production.
Aerospace companies collaborate with manufacturers with the required certifications, expertise, and facilities to ensure compliance with stringent industry standards.
Food and beverage outsourcing involves contracting external manufacturers for the production of: food products, beverages, or packaging. Outsourcing in this industry can cover tasks like food processing, bottling, or packaging, allowing companies to focus on branding and distribution. An example of this would be Coca-Cola outsourcing its packaging or bottling to external manufacturers.
While the specific companies involved in outsourcing manufacturing may change over time, here are examples of well-known companies that have historically been associated with outsourcing:
- Apple Inc.
- Nike Inc.
- Procter & Gamble (P&G)
- General Motors (GM)
- Johnson & Johnson
- Intel Corporation
- Microsoft Corporation
Yes. Nike is one of the biggest multinational companies in the world, outsourcing 100% of their manufacturing in apparel and footwear. Nike takes the approach of outsourcing all of their manufacturing to several independent suppliers around the world. They balance their supply chain, so they are not over-dependent on any one supplier, mitigating the risk of breaks in the supply chain if any one supplier cannot fulfill their quota.
Yes. Apple outsources most of its manufacturing and assembly to various suppliers. These suppliers are based mainly in Asia, with China being the largest manufacturing base by far. Apple gets access to a skilled, affordable labor force and efficient, low-cost production lines by outsourcing to these companies.
There are several advantages of manufacturing outsourcing including:
- Lower labor and production costs in other countries to help reduce costs. Manufacturing locally in different locations can also help reduce shipping costs when accessing global markets.
- Gives access to companies and personnel who have expertise in manufacturing that might not be available in-house.
- Can mitigate the risk of breaks in the supply chain—if one supplier faces difficulties—by using multiple suppliers.
- Partnering with manufacturers that are experienced and highly efficient can reduce the time required to bring a product to market.
- Allows for greater flexibility in scaling production up or down based on demand fluctuations.
Manufacturing outsourcing has some disadvantages and drawbacks:
- Maintaining consistent quality across outsourced production can be more challenging than if production were centralized.
- Companies become reliant on external suppliers for critical components or processes.
- Managing operations across different countries, time zones, and languages can add extra complexities and may lead to mistakes.
- Managing distant manufacturing facilities adds complexities to logistics, and can introduce extra shipping times and costs to transport products to the home market.
- Sharing proprietary information with external manufacturers raises the risk of intellectual property theft or leaks.
The origin of manufacturing outsourcing dates back to the 18th-century Industrial Revolution when technological advancements transformed global trade. Before this era, American businesses produced goods in-house, limited by location and distribution capabilities. The surge in productivity during the Industrial Revolution prompted a shift to mass production, leading to increased operational costs. Faced with challenges, businesses began outsourcing in ways that had been previously impossible. The expansion of the railroad system and the advent of the telegraph facilitated outsourcing, allowing businesses to produce goods in cost-effective areas and communicate remotely. Offshore outsourcing emerged in the 1970s, especially in consumer electronics, as companies realized the benefits of lower labor costs and increased profitability.
The growing global trend in outsourcing is still expected to climb in the near future, according to Forbes Magazine. However, there’s also an increase in reshoring manufacturing back to the US, which is expected to increase further in the upcoming years.
The difference between outsourcing manufacturing and IT outsourcing is outsourcing manufacturing involves contracting external companies to produce physical goods or components, often in industries like: construction, automotive, and pharmaceuticals. This process requires expertise in production, quality control, and logistics, and the output is tangible and physical. On the other hand, IT outsourcing pertains to contracting external service providers for various information technology services, such as: software development, IT support, and data management. IT outsourcing largely deals with intangible, digital services and requires expertise in software development, system administration, and cybersecurity. The industries that use IT outsourcing span a wide range, including: technology, finance, healthcare, and retail.
This article presented outsourced manufacturing, explained it, and discussed how it works and examples of it. To learn more about outsourced manufacturing, contact a Xometry representative.
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