In-house production pays off for businesses and can increase profits and productivity

In-house production is worth it, outsourcing harbors risks. So concludes the study, “The value of value added” by the Karlsruhe University of Applied Sciences and the Fraunhofer Institute for Systems and Innovation Research ISI. A major result of the study, which was funded by the Ministry of Finance and Economics Baden-Wuerttemberg, is the significantly positive influence that in-house value creation has on profit and productivity. This means that outsourcing to foreign suppliers should be assessed more critically. Manufacturing companies based in Baden-Württemberg currently already have above-average in-house value added, but should continue to expand this in future-oriented fields like electric mobility. “The study also makes it clear that: Industrial companies in Baden-Wuerttemberg are on the right track. They are building on their own regional value creation and are therefore among the best competitively”, says Nils Schmid, Minister of Finance and Economics in Baden-Wuerttemberg.

Types of company specified on vertical integration and sourcing from abroad
Types of company specified on vertical integration and sourcing from abroad

The Institute for Learning and Innovation in Networks (ILIN) at the University of Applied Sciences in Karlsruhe and the Fraunhofer ISI conducted a joint study “The value of value added – advantages and necessity of local value chains”. On behalf of the Ministry of Finance and Economics in Baden-Wuerttemberg and the Institut für Produktionserhaltung e. V. (Infpro), the value chains of German companies and those based in Baden-Wuerttemberg were examined, how these are constructed, and which opportunities and risks are associated with this.

Coordinator of the study and head of the ILIN, Professor Steffen Kinkel, summarizes the main finding as follows: “The results clearly show that creating and expanding in-house value added pays off from an economic perspective and creates potentials for profit and productivity“. In contrast, importing intermediate inputs does not provide any significant potential contribution. The study also analyzes the related consequences for the future field of electric mobility as an example.

Manufacturing companies in Baden-Wuerttemberg show above-average vertical integration with almost 39 percent in 2013, which was significantly above the average for Germany. Well-founded insights into the structure of value chains and the resulting opportunities and risks were the result of analyzing the Fraunhofer ISI‘s “German Manufacturing Survey” of 1594 industrial companies in Germany, and 16 expert interviews with representatives of leading companies in Baden-Wuerttemberg.

A modeling analysis of cost structure data from the German Federal Statistical Office, also conducted as part of the project, shows that increasing a company’s vertical integration by one percentage point is accompanied by a 0.2 percentage points increase in its profits. Moreover, the total factor productivity and labor productivity of a company are also strongly positively influenced by its degree of vertical integration.

The study also underlines the lack of any positive correlation between imported intermediaries from foreign suppliers and the economic development of a company. “The cost reduction potentials of external procurement are offset by higher spending on coordination in order to ensure flexible reaction and delivery in the supply chain“, explains Dr. Oliver Prause, Chairman of the Board of the Institut für Produktionserhaltung e. V. (Infpro). There has indeed been an increase in the imported share of intermediaries in Germany‘s manufacturing sector over the past few years, but the strategy of local sourcing is still firmly in place. Lower price segments and large batch sizes with low variance tend to be purchased in the Far East, but suppliers in Asia are usually not flexible enough to provide smaller quantities or varying, customer-specific requirements.

Dr. Djerdj Horvat, project coordinator at Fraunhofer ISI, sums up: “Local maker businesses combine the productivity advantages of integrated production with the flexibility advantages of a high local supply of intermediates“. (See diagram).

The study’s results are also relevant for the economy, because the automotive industry in Baden-Wuerttemberg and Germany could be facing changes in its value added structure in the future due to the shift towards electric mobility. The powertrain currently accounts for about one quarter of the value added of fossil fuel-powered passenger cars. And this is precisely where German manufacturers’ have their core competence. Germany and Baden-Wuerttemberg harbor future potentials, especially in electric motors, power electronics and lightweight construction. But these are contrasted by weaknesses in other fields like traction batteries and fuel cells. Correspondingly, mobility scenarios that assume a strong development towards electric mobility threaten a loss in the domestic value added of German automobile producers of 19 percent compared to a conservative scenario. According to the study’s findings, this corresponds to a potential profit reduction of 3.8 percent. Given this background, it seems essential to push the relevant activities to ensure the automobile manufacturers and suppliers in Baden-Wuerttemberg have sufficient own value added in the future-oriented field of electric mobility.

The Fraunhofer Institute for Systems and Innovation Research ISI analyzes the origins and impacts of innovations. We research the short- and long-term developments of innovation processes and the impacts of new technologies and services on society. On this basis, we are able to provide our clients from industry, politics and science with recommendations for action and perspectives for key decisions. Our expertise is founded on our scientific competence as well as an interdisciplinary and systemic research approach.