Question

Managers should answer the following questions when considering outsourcing:

How do the company’s variable costs compare to the outsourcing costs?

Are any fixed costs avoidable if the company outsources?

What could the company do with the freed manufacturing capacity?

Answer 1

Outsourcing describes a company's decision to purchase a product or service from an outside supplier rather than producing it in house.

1. Manager should compare the variable costs that are incurred in house during production and compare with the outsourcing cost. If the variable is less than outsourcing cost, then in house cost is preferable over outsourcing.

2. Avoidable Fixed Costs + Relevent Variable Cost constitutes Relevent costs . Relevent cost of keeping activities in house versus outsourcing to external suppliers. Avoidable fixed costs should be considered during outsourcing activity.

3 .Contract manufacturing can provide a win win relationship if one firm has excess capacity or expertise and another company lacks capacity or knowledge. Company can rent the excess or freed manufacturing capacity or produce some other products that can maximise the performance of an organisation in terms of profitability.