103 5.3 Make or Buy, In-sourcing or Outsourcing

Objectives

By the end of this section, you should be able to:

1.  Identify the key elements of the make-versus-buy decision.

2.  Identify the benefits and problems with outsourcing.

3.  Explain role of Procurement function in outsourcing.

 

Introduction

One of the most critical decisions made in any firm concerns make or buy. When any firm starts its life, a whole series of make-or-buy decisions need to be made and as the firm grows and as it adds or drops products and/or services from its offerings, make-or-buy decisions continue to be made.

Before we proceed to explore other elements of the make-or-buy decision, let us first distinguish the difference between in-sourcing and outsourcing in relation to make-or-buy decisions:

1.  In-sourcing: Refers to reversing a previous buy decision. An organisation chooses to bring in-house an activity, product or service previously procured from outside.

2.  Outsourcing: Reverses a previous make-decision. Thus, an activity, product or service previously done in-house will be procured from outside.

For any brand new product or service, make-or-buy decisions need to be made. Later, in view of new internal and external circumstances, these previous make-or-buy decisions are reviewed and some or all may be reversed. Clearly, there is a major role to play for Procurement in make or buy as well as in-sourcing or outsourcing.

We have discussed earlier that Procurement is responsible for investigating all potential suppliers and for placing the order with the supplier, which will provide a satisfactory product at the lowest overall cost to the firm in the long run. Among the potential suppliers that should be considered is the buyer’s own firm. In some cases, a firm may be able to make a required component or provide a service more effectively or economically than by buying it. A firm’s objective is to arrive at make-or-buy decisions whose composite effect optimises the utilisation of its productive, managerial and financial capabilities. Unfortunately, studies indicate that only a surprisingly small number of firms (large and small) have developed a comprehensive make-or-buy policy that provides for consistent analysis of specific make-or-buy questions.

In a going concern, past managerial decisions and the firm’s long-term plans often establish the current pattern of operations. Historical policy decisions may at times prompt a firm to provide certain parts or services internally even if it could buy more advantageously from outside supplier. Similarly, the pattern will also dictate that some parts or services will be procured from outside suppliers regardless of the firm’s capability. Within this framework, make-or-buy investigations often originate in one of several ways:

1.  New products/services: The development of a new product or service and the major modification of an old one are typical situations requiring make-or-buy investigations where a major part of the new product/service is studied to determine the most advantageous production and sourcing decisions.

2. Unsatisfactory supplier performance: Less than desirable performance by present suppliers may trigger the investigation into the possibility of making such parts in-house as well as the possibilities of improving the supplier’s performance or finding a more efficient supplier.

3.  Changing sales demand: Periods of significant sales growth or sales decline also generate situations that initiate make-or-buy analysis. For instance, reduced sales result in reduced production activity, leaving plant facilities and workers idle. When this happens, management naturally attempts to bring into its own shops work previously performed by outside suppliers.

4.  Restructuring/relocation: In organisational restructuring and facilities relocation exercises the fundamental questions such as ‘what business do we really want to be in’ are addressed. Then, make-or-buy analysis of individual parts or every product/service that aligns with ‘the business we really want to be in’ is carried out to identify the parts, which are most profitable to make or provide internally and those, which can be procured more economically from outside suppliers.

Make-or-buy possibilities may require small capital outlay for tooling or minor equipment, to making a sizable additional investment in tooling, facilities or know-how. The make-or-buy possibility requiring only a modest expenditure of funds in the event of a ‘make’ decision, is the type most commonly encountered by Procurement management. A decision of this type usually does affect a firm’s resource allocation plans; however, its effect on the firm’s future is much less significant than is a decision requiring a major capital investment. Although the decision requiring a nominal expenditure of funds/reallocation of resources may not require direct top-management participation, it does require coordinated study by several operating departments. Top-management’s responsibility is to develop an operating procedure, which provides for the pooling and analysis of information from all departments affected by the decision. In other words, management should ensure that the decision is made only after all relevant inputs have been evaluated.

 

 

  Reading
Please read ‘make-or-buy decisions’ on pages 158 – 160 in Chapter 5 from your textbook Procurement Principles and Management, 10th edn, England: Prentice-Hall, Pearson Education Limited by Baily, P, Farmer, D, Crocker, B, Jessop, D and Jones, D (2008).

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