Make-or-Buy, sometimes referred as outsourcing, is a decision on whether to manufacture a product in-house or to buy from an external supplier. The decision considers the costs and benefits of doing in-house or externally and comparing the two. The final decision of a Make v Buy should scrutinize both the total cost and wider strategic business benefits. Whilst the wider strategic benefits may be difficult to quantify, they often are the considerations that have the most weight.
A Make-or-Buy decision, also sometimes termed as an outsourcing decision, requires an organization to choose between producing a good or service in-house, or contracting a third party to deliver it.
The primary argument in a make-or-buy decision is around cost. Because, while contracting domestic suppliers to fill the gap in expertise and capacity is a common practice, western companies are increasingly looking at outsourcing their key functions to east Europe, Asia, and other low-cost regions that promise advantages such as low-cost labour, innovation skills, and scalability.
However, at the same time, there are risks associated with outsourcing which must be properly understood and mitigated as part of any buy decision. Furthermore, as opposed to the common practice, a make-or-buy decision transcends manufacturing and can also cover fundamental business functions such as Human Resources, IT, customer relations, maintenance and other areas of the organization.
Accordingly, the organization must review all important factors in an objective manner, and thoroughly evaluate all costs, benefits, risks and rewards of outsourcing an activity or keeping it in-house. They should measure the organization’s competencies against global standards and assess whether it’s possible to reach the required level of improved performance efficiently, and in time, to match or exceed the advantages derived from outsourcing, or not. That said, outsourcing shouldn’t be an alternative to internal efficiencies of an organization, especially when the organization has the capability and capacity to produce in-house.
A 2-Part Decision Making Process
The Make v Buy decision is informed by completing 2 parts to enable an organization to make an objective decision based on all the facts.
Part 1: Cost Analysis
The first part is a complete analysis of the costs of either solution. This should assess the total life cost (TCO) of both solutions.
Cost considerations for a ‘Make’ analysis
Some examples of costs that should be considered when assessing internal delivery:
- Raw material costs
- Direct labour costs
- Factory overheads
- Managerial costs
- Storage costs
- Holding costs
- Capital costs
- Waste management costs
Cost considerations for a ‘Buy ‘ analysis
Some examples of costs that should be considered when assessing external providers are:
- Purchase price
- Shipping costs
- Import fees
- Inspection costs
- Sales Tax
- Receiving costs
Part 2: Strategic Assessment
The second part is a strategic assessment by the organization of the good or
service. Is it a strategic part of the organization that directly impacts the performance and valuation of the organization?
A full view of requirements, analyses such as PESTLE, Porter’s Five Forces and Gap Analysis, can help inform make-or-buy decisions and reduce the likelihood of expensive consequences in the future.
Elements that favor a ‘Make’ decision
- the product, or part of the product, is critical to organization’s core function and competencies
- there’s existing idle capacity that can be used to absorb fixed overheads
- producing in-house will lead to revenue growth owing to faster cycles of internal innovation and product customization
- the development and delivery of that product is time-sensitive
- there are possibilities of frequent design changes
- self-reliance is an organizational goal
- the organization wants a stable workforce
- the organization is intending to produce large quantities
- the organization is intending to bolster the brand image
- secrecy is required to protect organization’s intellectual properties
- the location of a supplier is not ideal or there’s political instability in their region
- the organization anticipates retaliatory measures from unions
- outsourcing to a low-cost region could raise ethical or privacy concerns
Elements that favor a ‘Buy’ decision
- the organization lacks expertise to create the product, or part of the product
- the organization lacks capacity to produce in-house
- the organization wants to eliminate labor-intensive processes
- the organization wants to phase out training and paperwork
- there are limited quantities of product, or part of the product, required
- the product, or part of the product, is not critical to business strategy
- there are competent and reliable suppliers in the market
- there are multiple suppliers to encourage competition and gain leverage
- there could be an effective gain-sharing mechanism that rewards suppliers but passes on improvements to the organization
Conclusion
Make-or-buy decisions require a detailed assessment of a variety of price and non-price related factors. Both in-house production and outsourcing present a series of advantages and disadvantages to the buying organization that have significant and long-term impact on the business. Thus, the organization should compare the costs, benefits, risks and rewards associated with each of the options before arriving at the solution.
Key Takeaways
- The final Make-or-Buy decision should be taken after scrutinizing both cost-related and strategic factors.
- While total life cost of either option is an important factor, more weight should be assigned to strategic factors.