Make or Buy Decisions | UGC NET Commerce Preparation Course PDF Download

What Is a Make-or-Buy Decision?

A make-or-buy decision involves choosing whether to produce a product internally or purchase it from an external supplier. This process, also known as outsourcing, requires evaluating the costs and benefits of manufacturing the product in-house against sourcing it from another provider. To make an accurate comparison, a business must factor in all costs related to acquiring and storing the product, as well as the potential need for new equipment and additional labor if produced in-house.

Key Points:

• A make-or-buy decision involves deciding between internal production and external purchasing.
• These decisions require weighing the costs and benefits of both options.
• Several factors can influence outsourcing, such as labor costs, expertise, storage, contracts with suppliers, or insufficient production volume.
• Companies often use quantitative analysis to determine the most cost-effective option, though qualitative factors may also be considered.

Understanding the Decision to Make or Buy

Cost Considerations for In-House Production:

• Expenses related to acquiring and maintaining new machinery and equipment
• Cost of raw materials needed for production
• Additional labor costs including wages, benefits, and associated expenses
• Storage requirements within the facility
• Holding costs and disposal of production remnants or byproducts
• Ability to meet production requirements

Costs Associated with Buying from an External Source:

• Cost of purchasing the product itself
• Shipping, importing fees, and applicable taxes
• Storage expenses for incoming products
• Labor costs for receiving and managing inventory
• Contractual obligations with suppliers, including price-locking agreements

Role of a Chief Procurement Officer:

Make or Buy Decision

• A quantitative analysis might provide enough information to determine which option—making or buying—is more cost-effective. However, in some cases, a qualitative assessment is necessary to address concerns that can't be easily quantified.
• For instance, reasons for opting to buy a component instead of producing it in-house may include limited internal expertise, low production volumes, a preference for multiple suppliers, or the fact that the component isn't critical to the company's strategic goals or competitive differentiation.
• A company may lean further toward buying if it can collaborate with a supplier that has a proven track record and can establish a long-term partnership.
• On the other hand, reasons for producing a component internally might include available production capacity, better control over quality, or the need to protect proprietary technology. Concerns about a supplier's reliability, particularly if the component is essential to business operations, may also push the company toward in-house production.

If outsourcing is the chosen route, it's crucial for the company to select reliable suppliers that can support a lasting relationship.

When to Reverse Course

• There may come a time when a company must pause and evaluate its next steps, deciding whether to purchase or produce the parts or products it requires, even if this means deviating from past practices.
• Such moments might include a reliable supplier going out of business (or facing potential closure), shifts in product demand, or emerging opportunities. During these times, management needs to reassess the benefits of producing in-house versus buying externally, beyond just a cost-benefit analysis. The decision could impact potential economies of scale, the introduction of new product lines, or a major restructuring of the core business.
• The choice between sticking with the current approach or pursuing a new strategy can offer both pros and cons, depending on the business and its market position.

What Is Procurement?
Procurement is the process by which a business or large organization, including government entities, acquires goods and services, usually on a substantial scale. It involves a strategic approach with various business decisions, unlike purchasing, which is more straightforward and focused on immediate needs.

What Is Outsourcing?
Outsourcing involves contracting another company to supply products or services that a business could potentially produce internally. Often, this means engaging with firms in other countries where production and labor costs are lower. This practice is sometimes known as offshoring, though the term can encompass broader business and financial meanings.

What Is Insourcing?
Insourcing is the practice of performing tasks within a company that might otherwise be outsourced. Companies choose insourcing to leverage their own capabilities, enhance internal expertise, or achieve other strategic objectives.

What Is Reshoring?
Reshoring, or onshoring/inshoring, occurs when a company moves tasks previously outsourced to foreign countries back to its home country. This decision may be driven by increasing labor costs abroad or a desire for better control over the supply chain.

The Bottom Line
Deciding whether to make or buy products can significantly impact a business, especially in competitive markets. These decisions are not permanent and should be revisited periodically to ensure they remain relevant and effective as circumstances change.