Purchasing leverage considerations in the outsourcing decision

Abstract

As outsourcing has increased, an unanticipated problem has come to light for many manufacturers: as they reduce their purchase volume with their materials and parts suppliers for inputs to items that are now outsourced, these manufacturers lose their volume and price leverage for the inputs. As a result, they may have to pay more for parts and materials that they continue to buy from suppliers. In addition, the contract manufactures to whom they outsource may also be paying a higher material/part price or may get a lower price by consolidating volume from a number of customers, but may retain the volume discount as part of their profit. This paper uses the transaction cost literature to explore how purchasing can best manage the potential loss of volume/purchase leverage for the inputs to items that are outsourced. In exploring this issue, case studies are used to demonstrate both unsuccessful and successful attempts at managing this loss of purchasing leverage. A prescriptive framework is developed that suggests how to best manage the risk of losing purchasing leverage when outsourcing. This framework considers the relative volume of the buyer and the contractor, the level of trust, and the concerns of the supplier regarding its price visibility.