Outsourcing can be an excellent avenue for exploring new revenue streams or cost savings without the burden of a heavy upfront capital investment. But the decision to outsource or expand internal capabilities isn’t always straightforward. There are many factors at play: recurring costs vs capital costs, maintenance fees, staff wages, project timelines, and more. An effective way to account for these variables and arrive at the most financially sound decision is to calculate the return on investment (ROI) of outsourcing and compare it to the ROI of internal expansion.
Informing decisions with the ROI equation
“A calculation of return on investment, or ROI, is a fundamental tool used in determining the value of a business investment,” says Sherri Bassner, PhD, in another Lab Manager story. At its core, ROI is a simple mathematical formula:
ROI = (gain from investment-cost of investment) / cost of investment x 100
The end result is a percentage, and the higher it is, the better the ROI.
While ROI might not be the sole factor in a business decision, it is a helpful foundation for formulating a more comprehensive business case and sparking useful discussions.
In the context of deciding whether to outsource or expand services internally, ROI will serve as a comparative value—that is, you’ll need the ROI of both outsourcing and expanding internally to see which would be higher across the project timeline.
To calculate the most accurate ROI for each option, you will need to collect several data points. Here are some examples:
Data points for outsourcing
- The recurring cost of outsourcing: How much you’ll pay a service provider to analyze each batch of samples or recalibrate your instruments, multiplied by the number of times they will perform that service for you
- Quality control: The time and money cost for your lab to QC the results delivered by the service provider
- Expected value increase: How much new revenue or saved time the outsourced services are expected to deliver
Data points for internal expansion
- Cost of new equipment: Likely to be the largest cost
- Training staff: Lab staff will need to step away from their other work to learn the new process and how to use the new equipment, so you may need to hire a specialist to train the staff. The opportunity cost of training should also be considered
- Hiring new staff: If you need to expand your team, you’ll need to account for the salaries and benefits of new team members, as well as onboarding time where they may not be producing value
- Equipment maintenance: Whether the instrument is maintained internally or by the service provider, it will cost either time or money
- Expected value increase: How much revenue or saved time that the new service will save the organization
Three foundational questions for ROI
Distilling down all the above considerations, there are three conditions that, if met, indicate you may be in a good position to outsource:
- You can afford all the one-time and recurring costs associated with outsourcing
- Outsourcing won’t compromise quality
- The savings and/or increased revenue from outsourcing will more than pay for the monthly costs in a reasonable timeframe
Accounting for the intangible
When considering ROI, don’t ignore the factors that cannot be quantified. Some intangible benefits, like improved customer experience or worker morale, can still positively impact the lab’s productivity. Likewise, negative intangible factors can decrease its productivity. Numbers never tell the full story—don’t neglect the human element.
The equation in action: an example
A newly minted lab manager, Carson must decide how to support a new nine-month internal research project: build the capability in-house or outsource it. A direct ROI comparison reveals the most cost-effective path for this trial period.
To perform the analysis, Carson used an internal chargeback of $8,000 per sample batch, with nine sample batches performed throughout the trial, for a total of $72,000 in chargebacks. Outsourcing costs are projected to be $6,000 per batch, totaling $54,000 for the trial.
ROI calculations for the nine-month trial:
In-house expansion
Upfront Investment: $85,000, which includes a $75,000 instrument, $4,000 for training, and $6,000 in opportunity costs
ROI = $72,000 - $85,000 / $85,000 x 100 = -15.3 percent
Nine-Month ROI: -15.3 percent, representing a net loss of $13,000 against the initial investment
Outsourcing
Total Cost: $54,000 for the nine-month trial ($6,000 per batch, including review and quality control)
ROI = $72,000 - $54,000 / $54,000 x 100 = 33.3 percent
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Nine-Month ROI: 33.3 percent, yielding a net profit of $18,000
Outcome: For the nine-month trial, outsourcing provides a significantly better return. It avoids a risky capital investment on a project that might be discontinued. The in-house option would only become more cost-effective than outsourcing on a longer timeframe, making outsourcing the more flexible and financially prudent choice for the project's initial phase.
ROI calculations for a long-term commitment:
The nine-month trial proved successful, so the organization decides to commit to the project long-term and hires a new junior scientist to carry out the work. With wages and benefits, the new hire is paid $67,500 annually. In the first year after the trial period, the project generates $144,000 in value, and the ROI is calculated cumulatively over 21 months (the nine-month trial plus the first year of operation) against the initial $85,000 investment.
ROI = ($216,000 total chargebacks - $67,500 salary) - $85,000 initial investment / $85,000 x 100 = 74.7 percent
With the ROI of internal expansion increasing to 74.7 percent over a longer timeframe, it becomes the superior choice for long-term commitment.
As these examples show, the choice between outsourcing and internal expansion is greatly impacted by the project’s duration. For a trial period, outsourcing is wiser. If the company then pivots to a long-term commitment, then internal expansion is wiser.
Key takeaways
Deciding between outsourcing and internal expansion is rarely straightforward, but using ROI as a guiding framework brings clarity. By comparing the costs, expected gains, and hidden factors like quality and opportunity costs, lab managers can make informed, confident decisions.
Short-term projects often benefit from outsourcing’s flexibility and lower upfront costs, while long-term commitments may justify investing in in-house capabilities. Importantly, ROI isn’t just about the numbers. Intangible factors like staff morale and customer satisfaction also play a role. By combining quantitative analysis with human insight, labs can strike the right balance between financial prudence and strategic growth.
