Sub-contracting vs In-house Production: The Costing Behind the Decision

Almost every manufacturer faces this question at some point: should we keep this step in-house or send it out? The answer is a costing question — but it is rarely as simple as comparing the in-house cost to the sub-contractor's quote. Here is the framework that actually answers it.

The naive comparison and why it misleads

The instinct is to compute cost in-house (material + labour + overhead) and compare to cost outside (the vendor's quote, usually labour + their margin on the work). Whichever is lower wins.

The trouble is what gets counted on each side:

• In-house cost typically includes fixed overhead — even though most of it does not actually go away if you sub-contract the work
• Outside cost typically excludes hidden costs — logistics, quality issues, lead time, IP risk, coordination overhead

The naive comparison usually flatters one side and the wrong decision follows.

The right framework: relevant costs only

The honest comparison is between the incremental cost of doing it in-house and the all-in cost of having it done outside, for the volume in question.

Incremental in-house cost includes:

• Direct material (same either way — usually)
• Direct labour (only if you would actually pay more / hire / lose elsewhere)
• Variable overhead (consumables, power, machine wear)
• Only the fixed overhead that genuinely changes (if you would close a line, that line's fixed cost is avoidable; if you would not, it is not)

All-in outside cost includes:

• The vendor's quote
• Inbound and outbound freight to and from the vendor
• Material loss in transit / at vendor
• Quality cost — incoming inspection, rework, returns
• Coordination cost — who at your end manages the vendor; that is a real cost
• Lead-time impact — longer lead times mean more inventory; that is working capital
• GST and the job-work mechanism — usually neutral but check

The two numbers, fairly compared, give you the right answer for the volume in question.

Capacity and the "in-house always wins" fallacy

A common pitfall: "we already have the machine and the people — in-house must be cheaper."

Sometimes yes, sometimes no:

• If you have genuinely idle capacity (machines and people you are paying for who would otherwise sit), the incremental in-house cost is low — mostly just material and consumables. In-house probably wins.
• If you would have to add a shift, hire workers or buy equipment, the incremental in-house cost is high — closer to the vendor's. Outside might win.
• If running this in-house displaces other higher-margin work, the opportunity cost of the displaced work is part of the in-house cost. Outside often wins.

The "we already have it" argument only holds when the capacity is genuinely uncommitted.

Strategic factors that override the math

Sometimes the cheaper option is the wrong option. Reasons to keep work in-house even when the vendor is cheaper:

• IP / trade secrets — the process is your edge; sending it out leaks it
• Quality control — you cannot get the consistency you need from anyone but yourself
• Lead time and flexibility — you need fast turnarounds the vendor cannot match
• Future capability — you are building a skill you want to own

And reasons to send it out even when in-house is cheaper:

• Focus — the work distracts from your core
• Risk diversification — vendor capacity gives you a backup
• Scale economies — a specialist vendor is faster, better and improving

These are the qualitative factors that wrap the costing answer.

A simple worked decision

A small fabricator is deciding whether to powder-coat in-house or send out.

• In-house: 100 cabinets/month, ₹240 in material + ₹120 in labour + ₹60 overhead = ₹420/cabinet
• Vendor quote: ₹360/cabinet, plus ₹40 freight (in + out) = ₹400/cabinet
• Vendor has 5-day lead time vs in-house same-day — extra inventory cost ~₹15/cabinet
• All-in vendor = ₹415/cabinet

Numerically close. The decision then comes down to qualitative factors — what is the value of same-day turnaround for your customers, how is your machine utilisation otherwise, can you redeploy the powder-coating worker to higher-margin work, and so on.

How Booksmor helps

Booksmor tracks job-work and sub-contracting alongside in-house production — the same costing engine handles both, so cost-per-unit comparisons are apples to apples. Hidden costs (freight, returns, rework on returned goods) are captured against the job-work order so the all-in cost is visible. Start a 30-day free trial and make make-or-buy decisions with real numbers.