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Is outsourcing really worth it in technology development companies?

7 September 2016

Time and time again you hear about advantages of outsourcing. Labor rate is certainly cheaper in countries such as India or China. Many sub-contractors located there have experience doing business with Western companies. You often hear claims that ramping up mass production there is easier and cheaper. There are myriad of firms in, for example, China competing for doing business with a Western company. I was swarmed with responses when I inquired a quote through madeinchina.com web-site. They even assigned a personal sourcing expert to me! Doing business with the companies that contacted me seemed easy. The e-mails were well written in a very pleasant tone. Paying for goods and services could be easily arranged through PayPal. It turned out, however, that not everything went as advertised.

Outsourcing to a Western company often follows a different logic. Getting a task or part made by someone who is an expert in this field seems like a reliable way to get what you want. They may have specialized equipment, knowledgeable staff, and likely they’ve done it before for someone else.

Thus, outsourcing and sub-contracting makes perfect sense in a technology developing company, right? Well, only sometimes. Outsourcing drawbacks are often under-estimated, especially by the non-technical decision makers. All factors need to be considered and measured when determining the best sourcing strategy. What may look good at first glance looks terrible in retrospect. Dollar value needs to be placed on wait times, sub-standard quality, unnecessary communication, shipping costs, uncertainty, and company image.

Industrial discipline and business ethics differences are vast between countries. Unfortunately, too many Chinese companies over-promise and do not adhere to own statements. This is true to lesser extent about many Western companies too. This is most prevalent with timeline commitments. Getting the business by any means is paramount. Once a business engagement is underway, a sub-contractor or an overseas supplier often starts to “drag their feet”. Such behavior must be factored in the project costs.

Over-promising with respect to product quality also happens too often. Following a drawing’s tolerances for outsourced mechanical parts, for example, is rarely to be expected. Quality of materials is often sub-par. How do you think an overseas supplier achieves such a low cost? Cutting corners is often the answer. Even for consulting work that doesn’t involve any hardware built, sub-par workmanship in often evident. I am aware of many instances when a software code sourced from India is of such poor quality, that it needs to be overhauled to an extent of being mostly re-written. Such issues are rarely resolved by making the suppliers re-do things right. Time pressures and shipping costs often force you to make do with what has been delivered.

Getting a sub-contractor engaged requires extensive and clear documentation. A vendor must be found among thousands of potential candidates. This requires often lengthy communication with each of them. Requirements must be thoroughly listed and explained. Pricing and timeframe must be negotiated. Follow-up explanations and discussions are usually needed as well. All this communication is very costly. Suppose you write an e-mail with a question to your supplier in China. If you are in North America, the soonest you are getting a reply is usually the next day. If it’s Friday, you’ll hear back next Monday. Thus, a four email conversation can easily take at least a week. This may not be a big deal when a simple part is sourced, but it slows you down considerably when significant joint development is required. A good example is an electrical connector I was recently involved in developing. The manufacturer in Taiwan was rather professional and responded to e-mails the same day. Nevertheless, all the communication delays compounded and the project that was supposed to take 3 months is still ongoing a year later! Countless hours were spent on presentations, drawing updates, meeting, teleconferences, and other communication activities. Most of the communication would not be required for in-house development. Much less would be required if the sub-contractor was located within driving distance.

We are living in a wonderful age of FedEx. Despite this, geographical distance still matters a lot. In addition to slowing down communication, long distance considerably affects shipping costs. Direct shipping costs may be high for large and heavy items. Indirect shipping costs are generally much higher still. Waiting for goods that are in transit or are undergoing customs clearance slows down product and technology development projects a lot. Often necessary communication with customs authorities also takes its toll on staff’s time. Combined, these shipping costs may be extremely high, often higher than the cost of goods themselves.

Factors listed above contribute to project’s uncertainty. An (uncertain!) monetary value may be put on schedule and cost risks. Surprises happen more frequently in projects that involve outsourcing. Company contracted may not perform to its commitment. A shipment may be damaged. Customs clearance may take longer. You may receive a part that is not to specs after all this waiting! Pricing is uncertain too. I was surprised on a number of occasions about extra fees I had to pay to a machining vendor. A lot had been said in press about challenges with intellectual property protection overseas, particularly in China.

Finally, your product perception is affected by who your sub-contractors are. “Made in Germany” may sound good and endorsing, while “Made in China” may turn many potential customers off. This is a very tricky subject as many companies cheat by stamping, for example “Made in Canada” label on parts that were nearly completely manufactured in China.

In light of all of the above, in-sourcing is often a practical strategy. This is especially true for a breakthrough technology developer. Management is too often scared of the idea of performing a task in-house that is not a “core competency”. However, it must be realized that, for instance, technical requirements for a component considered to be outsourced differ vastly from similar components. The amount of development to be done by an outsourcing company may be similar to the amount you would need to do in-house. For example, for one project we had to balance a rotor that contained a very strong permanent magnet. We have spent countless hours trying to find a local company capable of doing this (magnets cannot be shipped easily). Eventually, we found an experienced consultant who specialized in rotor balancing. After eight hours of his very expensive time and as many hours taken by two of our engineers to support him, the rotor was still unbalanced. This forced us to design a unique-in-the-industry balancing rig to balance this type of rotors. One month later, we were experts in balancing such rotors and it took us 30 minutes on average to balance one.

Such experiences taught me that an organization should not underestimate its ability to learn new things. A confident, intellectually curious and open-minded team can master many tasks that would otherwise need outsourcing. A team working within a technology development company must have the above qualities. It is an unfortunate fact that many team managers I have encountered are opposing in-sourcing in an attempt to avoid extra work. Surely, you would often start from zero and gain expertise slowly. However, time that it will take to gain this expertise may be less than cumulative time spent on sub-contractor search, communication, and waiting. A peculiar thing is that no one can estimate your task timelines better than yourself. This reduces uncertainty in task planning. Also, when your own team is doing more of the critical tasks, there are fewer complex interdependencies. These interdependencies contribute the most to unpredictability.

There is a saying that everything new is actually well-forgotten old. At present, my argument may sound old-school and be in divergence with currently popular trends. However, I am firmly convinced that a trend towards outsourcing, especially to cheap labor rate places has taken us too far. I have encountered too many instances where outsourcing does not make financial sense when all things considered. “Re-shoring” tendency currently picking up pace in the United States is the first harbinger of the trend reversal.

So when does outsourcing really work? To answer this, you need to perform careful accounting of all costs referred to above. Sometimes, outsourcing benefits will outweigh the costs. For example, if a long and healthy business relationship has already been established with a vendor, risks may be much smaller. Sometimes, performing a task in-house is not feasible for lack of equipment or regulatory restrictions. In this case an outsourcing strategy that maximizes benefits/costs ratio is to be looked for.

By: Vitali Tikhomolov, M. Eng., P. Eng., Senior Design Engineer, Vital Engineering Inc.