Ok, maybe the title is a bit provocative – this applies first and foremost to startup companies. This text is part two of Introduction to Lean Production Scale-Up Model. You can find the first part here.
What happens throughout the production scaling of a startup is a lot of learning in two equally essential sectors: From the market and customers’ needs (the market build-measure-learn loop), but also about the production process (the production build-measure-learn loop).
In the early stages of production scale-up, all work must focus on optimizing the learning process that can be best achieved when the production is done in-house. When using a subcontractor in the early stages of development, the company will also find it difficult to continue to the later stages of scale-up because the subcontracting partners hold the tacit knowledge and thus the negotiation power in the developing partnership.
It is tempting to outsource production or parts of it to speed up the development and reduce the need for capital investment. Subcontracting can indeed offer very tangible and attractive benefits: Facilities and supply chains are ready, and the need for upfront investments is limited to name a few, but these benefits are not related to the primary goal that is the efficient learning. If a subcontractor does the production at an early stage, the learning will happen at the subcontractor, not internally at the company.
Using a subcontractor also fights against some of the Lean principles. A subcontractor adds additional layers of management and material handling that do not add value to the customer. Additional material handling is especially the case if the subcontractor is used to do only some parts of the production. In such an arrangement, materials are loaded and unloaded between a different location that does not serve as a value-adding function.
An additional difficulty of using subcontractors in the early stage is the lack of incentives for the subcontractor to do continuous development of the production process and the suboptimal operational infrastructure of the subcontractor. Example of misaligned interests and operational infrastructure between the company and the subcontractor could be a situation where the company learns the clients want to pick up products evening time, but the subcontractor has nobody working after office hours. When you are the only client the subcontractor has requested this change in working hours you know completing this change will cost you a lot. In general, the subcontractor has minimal incentives to modify its operations to match the needs of one small client the best possible way.
One clear benefit a subcontractor can have is access to better prices and hard-to-acquire parts and machines. If this is the case, a subcontractor could be used to produce subassemblies involving these parts and machines. Yes, this would be a step for more complex and expensive, most likely also slower, production, but if this way is seen as the fastest way to learn, then it is the correct way.
There are certain environments where in-house production is not a feasible option. Examples of these are regulated industries where you might have very long and expensive processes to get a certified production facility working from scratch.
If using a subcontractor is a must, the best possible option would be having the company’s own employees to run the production at the subcontractor’s facility. The need of hiring own employees can be restricted to the core functions of the production and to the parts that are related to the innovation, but the broader the scope of collected knowledge from the day-to-day work, the better. Warehouse management, packing, maintenance, and logistics are examples of the areas that could be left for the subcontractor to handle.
Hiring more than one subcontracting company is a method to position the hiring company better in long term negotiations. When the subcontractor is not the only one with the needed skills and machinery in place, the hiring company has a good position when difficulties eventually arise. In case of a poor performance of subcontractor or if the subcontractor wants to charge you more of their work, having an alternative or two gives the hiring company good negotiation power. Having a second subcontractor means some increase in cost related to managing the co-operating, but the costs should not double.
As explained earlier, one of the risks in working with subcontractors is the level of commitment for long-term co-operation. Financial investments for the joint project of production development by both parties can lower the risk. The subcontractor could invest in the hiring company and thus creating a clear incentive for developing the production together in the long-term. Other option could be establishing a common production company owned collectively by the innovation owner and the subcontractor. In the new company, the day-to-day management would be handled by the production professionals from the subcontractor, and the innovation owner would concentrate on research and development, marketing and other aspects of the business. The co-ownership would give both parties security as the success of the owners of the newly created company are intertwined.