Know Your Indirect Costs Before Outsourcing Your Manufacturing

Posted by Craig Zoberis

Mar 25, 2016 12:11:48 PM

Read Time: 2 Minutes, 30 Seconds

Outsourcing manufacturing is an important decision for any Original Equipment Manufacturer BLOG_77_PIC_1.jpg
(OEM), and often in the process of finding a reliable contract manufacturing partner (CM), an OEM overlooks a number of variables. By far, the most overlooked factor is indirect costs.

Before outsourcing, it’s important that you understand all of the true costs of manufacturing (direct and indirect). That way, you’re able to consider all of the factors involved when selecting and comparing different contract manufacturers. With a more level comparison, you’re better equipped to make the best decision for your business.

Many times, an OEM simply compares the internal direct costs of labor and materials to the final price of outsourcing manufacturing with a partner. However, your true cost of manufacturing a particular product line or piece of equipment isn’t just the sum of direct costs from your Bill of Material and manpower assembly costs – it’s much more.

Calculating Indirect Costs

What is often missing in these calculations is an account for your own indirect factory overhead costs (including both fixed and variable costs). To complete a true comparison of in-house manufacturing versus outsourced production, you need to calculate and consider your indirect costs, which often include the following factors:

  • Production floor space (including depreciation, rent and property taxes)
  • Production facility utilities (electricity, natural gas, water and sewer for all manufacturing facilities and equipment)
  • Production equipment costs
  • Miscellaneous material expense items
  • Inventory and inventory control
  • Production equipment depreciation
  • Insurance for equipment and facilities
  • Safety costs
  • Environmental costs
  • IT personnel (for all computer and communications systems used with the manufacturing functions)
  • Accounting department personnel
  • Purchasing department personnel
  • Receiving department personnel
  • Factory floor record-keeping personnel
  • Factory equipment setup personnel
  • Production equipment maintenance personnel and outside repair support costs
  • Supplies for operating production equipment
  • Production floor janitorial service personnel
  • Material handling personnel (such as forklift operators who move materials throughout the factory)
  • Inspection department personnel
  • Factory management personnel
  • Other general and administrative costs (G&A)

The Most Important Cost to Your OEM

All of these in-house manufacturing BLOG_77_PIC_2.jpgexpenses pale in comparison to the most important cost of all: opportunity cost. When your production facility is tied up with non-core products, you bog down your company’s ability to provide up-to-date products that your customers expect in a timely manner.

So, the next time you sit down to compare your outsourced manufacturing options against your own in-house expenses, consider the opportunity costs that might not show up initially. When you truly contrast the price of outsourcing production to your internal opportunity costs, the best business solution becomes immediately apparent.

An Outsourced Production Costs Case Study

Here’s one example of how outsourced manufacturing services saved a particular OEM on indirect costs and kept their factory floor clear for newer, more promising business opportunities:

  • The contract manufacturer received a single purchase order for 300 units of a particular product. (The OEM didn’t have to complete any other steps.)
  • The procurement and receiving departments purchased and processed 141,600 parts from 52 outside suppliers over a five-week timeframe. They managed orders with commercial component suppliers, electrical component suppliers, raw material suppliers, sheet metal suppliers and a plastic injection molding company.
  • The contract manufacturer’s machine shop managed 1,837 CNC machining center hours to manufacture 10,500 parts over the same five-week period.
  • The assembly department managed 4,277 assembly hours to produce the 300 ordered units over a nine-week timeframe.
  • The production crew included five electrical assemblers, four mechanical assemblers and one quality control (QC) inspector.

Throughout the entire process, the OEM didn’t have to handle or manage any of these details, calculate any individual indirect costs or lose any opportunities due to production distractions.

The next time your OEM decides on outsourcing manufacturing, remember to calculate your own in-house, indirect costs before shopping for the best contract manufacturer. Once you have a complete picture of your own production costs, you’re able to make more informed decisions on which outsourced production partner is right for your business.

Topics: contract manufacturing