Thanks
Nazi Germany was, in short, critically short on manpower, particularly for projects that were undesirable. The idea behind the camps, particularly the large scale ones, was not simply the industrialization of murder, but first to wring every last ounce of useful labour out of the bodies of those that inhabited them. There is a sad irony in this, as the horrid working conditions and meagre rations significantly reduced the effectiveness of that labour, a problem that was common in all the concentration camps as well as among polish and Czech 'free' labourers. As one might expect from a policy built on hate, the desire to eliminate these people was heavily counter productive to the need for their labour, and I use that word most deliberately because without that need many more would likely have died. Of course, Germany would have been better off if those men and women were actually in the labour pool as Germans, but chalk that up to yet another reason why the Holocaust was so devastatingly insane. Nazi Germany is the premier example of cutting off your nose to spite your face at the state level. Remember that any time someone says _Hitler was good for Germany."
It is important to note the distinction between camps established in Nazi Germany and the territories under Nazi occupation. The Reichssicherheitshauptamt (Reichs Main Security Office) eventually implemented genocidal policies that advocated wanton and wholesale slaughter, while the Wirtschafts-Verwaltungshauptamt (Economic and Administrative Department) sought to exploit labour by working prisoners to death. This was, as /u/spoonfeedme suggests, because the latter recognized the grave shortage in manpower by 1942-1943. On the other hand, the former believed that extermination was a moral imperative. In short, both organizations believed that Jews and other undesirables should be annihilated, but they did not necessarily agree on the process of destruction.
Once you start drastically increasing the amount of people, killing them actually takes a good amount of time. Think about how many individuals just 1000 people is. In Eastern Europe, SS units would line up whole towns in front of pits a few dozen at a time and gun them down, line up others and repeat; now you're using a large amount of bullets, manpower and time to kill unarmed civilians, resources that cannot go towards the rest of the war effort.
SS leaders also expressed some concerns about the negative effects more up close and personal methods, as well as massed firing squads, would have on the men. Firing squads themselves were meant to slightly insulate the perpetrators from personal responsibility, since massed firing at a close distance meant it would be difficult to single out victims that you yourself had killed. While these men were on the whole hardened killers, it is still difficult to massacre unarmed women and children unless you are a complete psychopath and unquestioning believer in the ideology. Even Himmler himself was said to have nearly turned ill when he witnessed these mass shootings of civilians for the first time. In a more pragmatic sense, manually killing people takes even more time; how many soldiers and how long does it take to cut 1,000 throats and bury the bodies? 10,000?
As others have said, most camps served a primary function of slave labor and political prison, with more of a complete disregard for human life than a mission statement to exterminate it. Only a few camps were truly dedicated to the mass slaughter of civilians, with only enough forced work to keep the camp running. As the noose tightened on the Third Reich and it became clear that not only might they lose, but their genocide be discovered or stopped, the outright killing of undesirables became a main objective. Gruesomely efficient as they were, the gas chambers still took time and resources; beyond expediency, one of their primary benefits was the removal of direct personal responsibility, as I mentioned.
Shirer, William L. The Rise and Fall of the Third Reich. New York: Simon and Schuster, 1960. Print.
That's exactly what they've done on Soviet soil - mass extermination of Jewish people on occupied territories since day one. Jewish ghettos were established in cities with sighnificant percentage of Jewish population (Vilno, Kovno, Lvov, Vinnitsa, Odessa etc).
In 1942 they've started Operation Reinhard - mass extermination of Jewish people in newly constructed extermination camps, ghetto in Lvov eliminated by Autumn 1943, for example.
So it's about technology, really. They've gathered particular group of people in the same place, and then methodically eradicated them.
As people have already said, the nazis were really short on manpower and using the camps as a way to supplement their labor force. The other issue that I haven't seen mentioned was the cost associated with that kind of extermination. When the nazis were beginning extermination at Auschwitz they originally had the guards shoot each prisoner and bury them in mass graves. However, the cost of each bullet added up when you're talking about killing that many people, so they wanted to find another way. The other issue was the psychological strain on the guards. Many of them had breakdowns or mental problems after killing that many people in cold blood, which is obviously understandable. They next tried explosives to lower costs and the contact between guards and prisoners but that was also psychologically damaging and messy as well, as many of the victims ended up with their body parts scattered in trees and across the ground, and there wasnt a 100% success rate. Even when they decided on gassing them, it was expensive and it ended up being easier and more helpful for the nazis to use them for manpower rebuilding bombed cities or working for the war effort.
You can get a pretty good answer by watching the movie "Conspiracy", a dramatic retelling of the Wannsee conference. (link below).
In addition to being an amazing movie, it will give you a good idea of how the Nazis themselves debated this very question. It's based on accepted historical facts.
That IS largely what happened.
According to Timothy D. Snyder's Bloodlands: the vast majority of the victims of the Holocaust never saw the inside of a concentration camp. They were simply killed outright in occupied areas of Poland and the Soviet Union. Either by the Germans themselves, or killed by local anti-Semitic groups encouraged by the Germans.