Meeting the Outsourcing Challenge


Our latest research explores the key reasons why companies outsource their manufacturing and/or logistics, the challenges they face, and how they are overcoming those challenges.


For over two decades, outsourcing of both manufacturing and logistics has been increasing at a pace more than double the growth in the overall economy. To better understand this fundamental business phenomenon, ChainLink recently conducted extensive primary research, surveying 125 manufacturers, distributors, and retailers, as well as the providers of outsourced manufacturing and logistics services. In this way, we could get both sides of the story. Here we will cover the following, primarily from the perspective of the users of outsourced services:

  • Growth in Outsourcing — in the past and future
  • Reasons for Outsourcing — what’s driving this growth
  • Challenges of Outsourcing — what key struggles do outsourcers still face
  • The Future of Outsourcing — where are we headed from here

Growth in Outsourcing

Outsourcing vs. Offshoring

Figure 1 – Outsourcing vs. Offshoring

To start, we want to make the distinction between outsourcing vs. offshoring, which are interrelated, sometimes overlapping, yet distinct and separate phenomena (see Figure 1). They are too often conflated in discussions about how much manufacturing has moved to China and the potential for some of that production to be reshored back to the US (for more on that topic, see Will International Trade Increase or Will We Reshore and Insource?). In fact, there are quite a few companies outsourcing their production to a domestic contract manufacturer rather than offshore — i.e. they are outsourcing but not offshoring. Conversely, manufacturers may offshore their production overseas without outsourcing — they maintain ownership of those overseas production facilities.

Outsourcing Growth To-Date

While there has been considerable debate about whether offshoring is slowing or even reversing, there has been less discussion about whether manufacturing and logistics outsourcing continues to grow across manufacturing and logistics. Double-digit compound annual growth rates (CAGRs) have been the norm in many manufacturing outsourcing sectors. For example global pharmaceutical contract manufacturing has grown at over 10% CAGR over the past several years. Electronics Manufacturing Services grew at 12% CAGR over the past 15 years. Similarly, the outsourcing of logistics to third party grew at 9.4% CAGR during the last 15 years, more than twice the rate of the overall GDP growth.

Source: Armstrong & Associates
Figure 2 – Third-Party Logistics Growth – 1996 – 2014 (9.4% CAGR) review

Outsourcing Growth in the Future

In our research, we wanted to see if this trend to ever-increased levels of outsourcing is continuing in the near future. We surveyed 125 manufacturers and their outsourced service providers and found on average they expect to increase their outsourcing in both manufacturing and logistics at a healthy pace — about 5% more a year from now than they do today, for both manufacturing and logistics. This represents a CAGR of nearly 20% for each of these.

Figure 3 – Continued Growth in Outsourcing of Manufacturing and Logistics

Reasons for Outsourcing

Given the increasing importance, we wanted to find out why companies outsource, what challenges they face and what solutions they are using to solve those challenges. The results of our survey, shown below, are the top reasons companies outsource manufacturing and logistics.

Figure 4 – Reasons for Outsourcing

Cost Reduction Still King — But the Means to Achieve It are Evolving

The number one reason for outsourcing is still cost savings. Lower cost labor is certainly an important part of the equation. But the equation is not so simple anymore. For one thing, companies have learned hard lessons over the years about the challenges of managing third parties, unanticipated additional elements of total cost, and in many cases reduced flexibility that comes with long extended supply chains. Furthermore, labor rate arbitrage is less compelling as wages and the standard of living have been continually rising in China and other developing countries. Thus companies can no longer rely purely on lower labor costs, but are looking for outsourcing partners that drive cost out in other ways, such as novel uses of technology, innovative processes, unique accumulated knowledge, and enlightened labor and skills management.

Access to Specialized Capability, Rapid Time-to-Market, Flexibility Are Key Drivers

The article Outsourcing and the Age of Rapid Startups and Hyper-specialization discusses the growth of the rapid project team model, leveraging discovery/brokerage and rating/trust technologies to quickly find and select the right partners on a per project basis, as well as the forces pushing firms to hyperspecialization. These trends are reflected in the second, third, and fourth reasons that people outsource: access to specialized expertise and equipment, rapid time to market, and flexibility to expand, contract, and move.

The ever-increasing breadth, depth, and penetration of technology is a key driver of this specialization. It has been a long time since the majority of products were manufactured using generic shop equipment (i.e. human operated lathes, saws, drill presses, looms, etc.). Highly specialized robots and computer controlled factories are the norm and get more sophisticated each year. Ongoing improvements in automation continually eat away at labor as a percent of total cost and key driver for outsourcing, while continually driving the need for more and more specialized equipment, expertise, and increasingly expensive factories. The semiconductor industry is a bellwether example of ever-increasing equipment costs and specialization, resulting in the current situation where the vast majority of semi-conductor companies are fabless, relying on contract manufacturers to actually fabricate the chips.

Challenges of Outsourcing

Next we wanted to understand the key challenges companies faced in outsourcing their manufacturing and/or logistics functions.

Figure 5 – Challenges with Outsourcing

Outsourcer Performance is Top Challenge

The top challenge cited by survey respondents was managing the performance of their outsourced service providers. It is echoed in the third most cited challenge, non-compliance with specifications. Manufacturing and logistics are such critical functions, embodying the company’s brand, creating the customer’s experience, and directly touching customers as the face of the company; thereby significantly impacting customer satisfaction and market share. In this sense, the performance of outsourced service providers for manufacturing and logistics is more critical than outsourcing of inward-facing functions such as IT, facilities, legal, or payroll. Manufacturing and logistics are also much less standardized (compared to say payroll or lawn mowing) and require developing strategic partnerships and deeper integration with the outsourced service providers. Integration with outsourced service providers covers both process and technology integration. In fact, one mistake earlier outsourcers made was shedding too much of their manufacturing or logistics expertise. They discovered that making these outsourced relationships work well requires retaining a very high level of knowledge about those functions.

The Cost-Reduction Tug-of-War

Source : Photo by RDNE Stock project from Pexels

Second on the list of challenges expressed by survey respondents who use outsourced services was managing escalating costs. On the other side of our survey, the outsourced service providers cited their number one challenge (by an overwhelming majority) as “Price competition/maintaining margins.” This never-ending tug of war — buyers seeking year-over-year cost reductions, while outsourced service providers try to maintain margins and avoid commoditization — drives both parties (but especially service providers) towards innovation and creativity in the way they do business. Outsourced service providers constantly seek ways to differentiate their services, create barriers to entry, and become more embedded in their clients’ businesses. This brings us back to the theme of specialization. This differentiation and specialization can take many forms, such as:

Source: Photo by Tima Miroshnichenko from Pexels
  • Specialized equipment — e.g. 10 nm multiple-patterning EUV lithography for semiconductor fabrication, biotech equipment (e.g. shaking incubators, refrigerated centrifuge, magnetic stirrers, DNA Gel Box, DNA Sequencer, etc.), heavy haul and specialized rigging equipment (e.g. knuckle boom trucks, lowboy trailers, etc.), specialized reefer ships, 5-axis CNC router, specialized 3D printers, and so forth.
  • Specialized expertise — e.g. semiconductor yield management, specialized manufacturing processes and material handling.
  • Access to specialized materials — e.g. specialty fabrics, specialty chemicals, nanomaterials, rare alloys or ores, unique provenance crops, etc.
  • Customized integration — with the customer-specific systems, organizations, and business processes/methods.
  • Local/regional market knowledge — accumulated experience navigating local regulations and enforcement, specific bureaucracies, labor market/practices, tastes, traditions, customs.
  • Industry-wide Data Mining and Benchmarking — outsourced providers of sufficient scale may be able to aggregate information to let their customers view industry-wide trends in pricing, lead times, port congestion, performance, labor rates, and other valuable information. Some providers can help their customer benchmark their performance against peers.

Across the Great Divide

The fourth, fifth, and sixth challenges are interrelated: Language and cultural barriers, lack of transparency and visibility, and reputational issues (poor labor, safety, and environmental practices). These issues tend to be more acute in outsourced manufacturing than in outsourced logistics. Outsourced partner selection will not be made solely on these, but the same skills and capabilities that overcome these barriers can usually help a service provider with the higher priority issues of performance and compliance.

The Future of Outsourcing

Technology enables ever-increasing specialization and an ever-more complex web of companies to operate together to perform the intricate, interwoven set of tasks required to create goods and services and bring them to market. The integration points between companies have gone way beyond EDI, to incorporate complex CAD and other types of detailed electronic specifications (down to instructions driving actual machine execution), real-time “IoT data” from factories and vehicles on current disposition, detailed test and inspection results, technical certifications, inter-enterprise social networking capturing and aiding the human decision-making process, real-time collaboration tools, inter-enterprise and multi-enterprise optimization algorithms (e.g. vehicle routing or load sharing, factory utilization), all the way to strategy brainstorming, ideation, and joint concept development.

A high level of integration is not just a win for the outsourced service supplier, who becomes much more embedded and integrated into their customer’s firm. Indeed, managing the outsourced partner network well is a key requirement for competitiveness in the modern global economy. To the extent multiple cooperating, tightly integrated enterprises can plan and execute in a coordinated, rapid, and responsive way, the entire ecosystem of outsourced partners becomes more competitive in this increasingly competitive world.

Conclusion: The Outsourcing Paradox

Our research has uncovered this paradox in outsourcing — that cost reduction is still an overriding driver of these relationships, yet outsourced services, especially in manufacturing, resist commoditization. There is a lot of potential to innovate, add value, and save costs in other ways besides simply lowest labor costs. We expect outsourcing to grow and become an increasing source of specialized expertise and capabilities, differentiation, and innovation — not just technology innovation, but also innovation in processes, business models, financial relationships, and inter-enterprise integration.

To view other articles from this issue of the brief, click here.

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