Definition: Outsourcing in managerial accounting is the decision to buy a product or pay someone to make it for you instead of making the product for yourself. This is usually considered when purchasing the product or labor to build the product is cheaper or more cost effective than manufacturing it in-house.
What Does Outsourcing Mean?
The concept of outsourcing labor became popular in the mid 20th century when US firms were looking for ways to cut costs and manufacture products less expensively. Since labor costs in Japan and other Asian countries were so much lower than the United States, many companies would set up manufacturing facilities in these countries and use local labor instead of US labor. This concept is now most commonly referred to as outsourcing jobs or moving jobs overseas.
Cost savings are the only thing that management uses in the outsourcing decision process. Many times there are opportunity costs and production capacity limits that have to be addressed as well. Let’s look at an example.
Big Apple Guitars, Inc. is looking to expand its product line but only has a limited amount of workers and machines. In order to make the new product line in house, BAG will have to stop or slow production on some of its existing products. Since this isn’t an option, BAG has to start looking at other options. They could either hire more people or they could pay another company to do the work for them.
Depending on the product and the cost of labor, BAG might decide to outsource the work to another local factory or even investigate the options of manufacturing abroad.
This is only one example. Many times companies close entire divisions and move the operations to countries like China or India. This is very common with customer support systems.