Opportunity Cost: One of the Most Important Factors in Comparing Outsourced Fulfillment
When comparing the cost of in-house fulfillment to the cost of using an outsourced fulfillment provider, companies will often fixate on the hard costs associated with outsourcing. The most frequently analyzed costs seem to be related to order fulfillment, storage and shipping.
In some cases, fulfillment companies can show monthly savings over in-house operations; this is largely due to shipping discounts that fulfillment providers receive coupled with costs savings due to aggregation of labor and space over multiple clients. However, in other cases, the hard costs of outsourcing alone don’t produce cost savings, leaving a company thinking that outsourcing warehouse operations isn’t justified. But when an analysis of outsourced fulfillment costs results in little to no cost savings over in-house fulfillment costs, there’s still one widely overlooked cost that has the potential to sway the analysis in the favor of outsourcing. This cost is the opportunity cost associated with performing fulfillment with in-house staff.
What is Opportunity Cost of In-House Fulfillment?
According to Investopedia, opportunity cost is “the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.” In terms of fulfillment solutions, the opportunity cost of choosing to keep warehouse and order fulfillment in-house is that your staff will be strapped with performing these activities instead of other functions. In some cases, the employees charged with handling in-house fulfillment are warehouse personnel. But in other cases, it’s administrative employees. Regardless of who processes the actual work, there’s almost no doubt that company management, to some extent, will be involved in the process.
The baseline question that needs to be asked by management is, “What is the best use of in-house labor resources?” If the greatest amount of value can be derived from charging staff with managing inventory and shipping activities, then outsourcing will likely not achieve greater return on investment. However, most frequently, companies can achieve a significantly higher ROI through outsourcing instead of processing this work in-house, especially when factoring for administrative labor and management time.
Opportunity Cost of Fulfillment in Action
Perhaps the best way to see the effects of opportunity cost is to take a look at a concrete example. Let’s assume that in addition to some warehouse staff, an organization also utilizes 20 hours of service time from administrative staff and 10 hours of management time to handle in-house fulfillment operations. Typically, these costs are ignored in making an in-house versus outsourced fulfillment analysis. At a baseline minimum, these hard costs should be factored into the analysis. Assuming that the average hourly rate of an administrative staff is $16.09, and the average hourly rate of a general manager is $24.41, the total cost of administrative and management time of managing
Assuming that the average hourly rate of an administrative staff is $16.09, and the average hourly rate of a general manager is $24.41, the total cost of administrative and management time of managing in-house fulfillment would be $565.90 (Statistics courtesy of Statistic Brain). But that’s not opportunity cost. Opportunity cost in this scenario would be the revenue that could be generated by these 30 hours if the company outsourced with a fulfillment company. If this time could generate more than $565.90, then perhaps there’s a better way to utilize these employees’ time each month.
What are You Giving up by Doing Fulfillment In-House?
Utilizing an opportunity cost perspective when comparing fulfillment options helps companies truly understand the significance and importance of labor resources. In fact, a good question to ask when making this decision is, “What is our company giving up by doing fulfillment in-house?” This will help companies factor for other mission-critical or revenue-producing work that might get sidelined. What types of things might produce more value than processing customers’ orders? Just a few examples include:
- Sales and marketing functions that bring revenue in to the company
- Strategic planning that helps the company save money or increase revenue
- Mission-centric work that has enormous intrinsic value
So by all means, go ahead and crunch the numbers for in-house versus outsourced fulfillment costs. But don’t make the same mistake most companies make when performing this analysis—remember to include the opportunity cost of having your in-house staff perform warehouse and shipping duties. Chances are, you’ll have an eye-opening experience by finding out that your internal group can produce quite a bit more value by spending their precious time on functions that have a greater potential for return on investment.