Making Outsourcing Decisions With Incremental Analysis

Managers are frequently faced with the decision to perform a task or manufacture an object in-house or to hire an outside vendor to perform the function. Outsourcing decisions are usually driven by economics: work is outsourced if it can be completed at a lower cost or in a shorter time than it can in-house. A technique termed incremental analysis can be used to make this decision. Incremental analysis examines the financial impact of outsourcing decisions as a function of the firm's fixed and variable operating costs. To use this tool, individual components of production cost are identified as being either constant or varying with levels of production activity. The assignment of cost type can be made in several ways: though analysis of historical operating data, understanding of individual expense types, and so forth. Changes in fixed and variable costs resulting from each potential course of action are explicitly identified to project the financial outcome of each alternative. The alternative having the greatest positive impact on profit is selected for implementation. By using the fixed- and variable-cost framework, the analysis is conceptually straightforward and substantially simplified. Production managers can therefore use incremental analysis as a tool for fast economically beneficial decisions on a real-time basis.