The Make-or-Buy Decision: Struggling to Stay Competitive or Pushing to Stay as Leader– An Option That Must be Considered…

Make-or-buy is a strategic decision most organization must make in today’s highly competitive global markets– it’s  a decision between ‘making’ product, service… internally, within a company, or ‘buying’ it externally, from outside suppliers– it’s a basic decision that impacts a company’s strategic planning…

According to Polly S. Traylor; it’s a question of Shakespearean proportions: Should you license a commercial enterprise application that meets 75% of your needs, or is it more noble to build your own application, one that tracks as closely as possible to task at hand? Decades of trial, error, and egghead analysis have yielded consensus conclusion: Buy when you need to automate business processes; build when you’re dealing with the core processes that differentiate your company.

An organization must consistently question the performance for all the activities for its value creation, e.g.: What performance is necessary to effectively compete in the market? Could improvement be achieved with some other form of external supply?

Most organizations are facing increasing competitive pressure, e.g.; need to achieve developments more rapidly, aging technology and processes, threat of excessive or insufficient in-house capacity…These questions are strategic in nature, in terms of; cost, quality, flexibility, reduced overheads, economy of scale and technologies…

Hence, a closer consideration and examination of the make-or-buy option is essential in today’s business environment… But, these are difficult questions requiring special management skills to identify, evaluate, and compare the relevant costs of using external or internal sources of supply…

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According to Brian McClure; make-or-buy decision can be just about anything you use in your organization regardless of the product, service.. these decisions are about looking at what make in-house and when to buy from outside the company… A make-or-buy decision involves a number of criteria, e.g.; looking at overall market potential, time-to-market, special requirement of the market; looking at current assets– utilization of your different facilities in different geographies and capacities; looking at your technology– evaluating the state of its competitiveness…

The challenge most companies face is that the ‘buy’ solution, which often might look more attractive in terms of ‘speed to market’ and ‘reduced overhead’ than the ‘make’ decision, but in reality when you look at the risks associated with the ‘buy’ model– it can be more costly than if you made the investments in your own infrastructure… Moreover, it’s not a simple matter of adding up the cost numbers– there are always unknowns, uncertainties that are impossible to quantify…

Often, the apparent lowest cost is not always the best option, and quantifying the risk is the hardest part… There are hard and soft numbers and often the soft numbers are much harder to put into the company’s framework of an investment strategy… It’s a struggle– you don’t always get the numbers right, but you are always trying to get better at quantifying the risks…

There is a vast amount of literature that goes into great detail about the make-or-buy decision process. Historically, these analyses have focused on overall cost comparisons… whereas, contemporary works have taken a more holistic view by incorporating both qualitative as well as, quantitative factored into more complex frameworks… which is more in tune with today’s business scenarios… The most widely considered factors in a make-or-buy decision are typically; cost, core competency, availability of capacity…

According to Sanjay Murthi; there are two extremes of behavior among teams charged with making ‘make-or-buy’ decisions… One group believes they can make everything needed, and that no off-the-shelf solution will fit their needs. The other group believes that an off-the-shelf package will be much cheaper, and better able to fit their needs… Unfortunately, both groups can lead to disappointments, if not carefully considered. At times, going the internal route may make more sense while at other times, an external solution is better… however, more often than not a hybrid solution that uses both, internal and external, will be the best solution… but as they say– it just depends…

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In the article When to Make–When to Buy? by Pranjal Kelkar writes: The make-or-buy question represents a fundamental dilemma faced by many companies. The cut-throat nature of competitive market compels most companies to re-evaluate their existing processes, technologies, competencies… The make-or-buy decision is a process of making a strategic choice between producing an item internally (in-house) or buying it externally (outside suppliers)… So, the question that springs up consistently is; should a company make all of their own products, services… or should they buy some from suppliers?There is no single answer–some companies are highly integrated… while, other  companies are much more specialized… and still other, relying entirely on outside suppliers...

The make-or-buy decision is a complicated process due to various competitive factors, for example; increasing competitive pressure… efforts to become leaner by decreasing costs through better asset utilization, while maintaining high customer service level… company’s need to keep pace with rapid technology developments… financial cost implications, shortening development cycles and faster time-to-market… The highly dynamic-disruptive nature of today’s markets compels most companies to consider, and reconsider make-or-buy decisions… however, it’s not only about cost– there are many other reasons; its more than just an operation, tactical issue, its increasingly a strategic imperative.

According to David Burt, Donald Dobler, Stephen Starling; as a rule of thumb most companies should buy-outsource all items that ‘do not’ fit one of the following three categories: (1) critical to the success of a company’s product, service… including customer perception of important branding attributes; (2) requires specialized design, manufacturing skills, equipment, and the number of capable and reliable suppliers is extremely limited; (3) fits within the company’s existing core competencies, or those the company must develop for future plans… Items that fit in one of these categories are strategic in nature and should be made internally, if at all possible…

In the article Make-or-Buy; Three Pillars of Sound Decision-Making by Detlef Schwarting and Robert Weissbarth write: When considering a make-or-buy decision a company must conduct a detailed analyses and develop a framework to thoroughly evaluate– costs, benefits, risks, rewards… and the framework should be based on these three key pillars:

  • Pillar 1: Business Strategy— evaluate the stra­tegic importance of the product, service… as well as, the importance of their– process, technologies, skills… required to make them… These factors must be considered not only in light of the current competitive market envi­ronment, but also in anticipation of a changing market in the future… As a rule, choose in-house capabilities when it’s critical to the company’s growth, financial well-being, core competency… Conversely, seeking outside suppliers tends to be a good choice when companies are trying to; reduce  burden of capital or labor intensive processes, reduce costs, gain flexibility in response to changing demand, gain access to new process or technologies…
  • Pillar 2: Risks– evaluate the risks of outside supplier solutions as compared with in-house capability… this includes risks inherent in the process of; identi­fying, selecting, verifying… the right suppliers and structuring a workable ongoing relationships… When there are multiple suppliers, a single failure in the supply chain may not be fatal… but use of outside suppliers introduces such a wide array of new risks, a company must be keenly aware of any potential pitfalls with suppliers, and evaluate partners on the basis of their importance to the organization…
  • Pillar 3: Economic Factors— evaluate impact of outside suppliers on capital expenditures, return on invested capital, return on assets as well as, the possible savings achieved through use of suppliers… The primary focus should be to shift the discussion from the cost of a finished product, service… to overall cost of delivery to the end customer… To do that, a company must identify the supplier’s cost drivers and design a pricing mechanism that reflects the current underlying costs and how costs might change in future…

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Today the role of outside suppliers is stronger than ever before. It’s widely considered to be an integral part of business strategy… The contribution of the purchased inputs is estimated to be more than 50% of the sales revenue in many industries… In fact, such is the importance of suppliers that in recent years, management experts have highly recommended cross-functional collaboration in make-or-buy decisions methodologies.

There are widely different opinions about the nature, degree of involvement of various functions, such as; purchasing, marketing, R&D… depending on the project… However, one thing is for sure there is a greater need for collaborative efforts and better synergy between various departments in sorting out the various issues that need to be dealt with in making these decisions…

According to Puneet Kuthiala; expert judgment is very important in making make-or-buy decisions. There is no numerical analysis possible that can give you a black and white answer to the crucial questions– these are more qualitative issues that required subjective consideration that need to be made by experience people who understand risk, and know how to minimize it…