Make or Buy Decision | Management Optional Notes for UPSC PDF Download

Introduction

The decision to make or buy is a crucial aspect of management strategy, involving the choice between producing internally or outsourcing externally. This decision, often referred to as outsourcing on the buy side, arises from concerns such as dealer relationships, capacity constraints, and fluctuating demand. In today's fiercely competitive business landscape, companies must continually reassess their processes and technologies to enhance their bottom line through strategically informed make-or-buy decisions.

Strategic and Operational Considerations

• Make-or-buy analysis operates at both strategic and operational levels, with the strategic level focusing on long-term considerations. 
• Factors such as government regulations, market trends, and competition influence these decisions. Companies must align their production with their core capabilities and adapt to evolving market dynamics.

Lean Manufacturing and Outsourcing Trends

• The adoption of lean manufacturing principles has led to a surge in outsourcing, with companies increasingly sourcing subassemblies and outsourcing various activities, from logistics to administrative services. 
• The decision-making process for outsourcing is guided by principles outlined in literature such as World Class Supply Management, which emphasizes strategic criteria such as product criticality, specialized skills, and alignment with core competencies.

While make-or-buy decisions involve tactical and operational considerations, their strategic significance cannot be understated. By carefully evaluating these decisions in light of market dynamics and organizational capabilities, companies can effectively optimize their resources and enhance their competitive position.

Factors Influencing Make-or-Buy Decisions

Make-or-buy decisions occur at both operational and strategic levels, with various factors influencing whether a company chooses to produce a part internally or procure it externally.

• Considerations Favoring In-House Production

Several considerations favor the decision to make a part in-house, including:

• Cost Considerations: When it's less expensive to produce the part internally.
• Integration of Operations: Desire to integrate plant operations for efficiency.
• Utilization of Excess Capacity: Productive use of excess plant capacity to absorb fixed overhead costs.
• Quality Control: Need for direct control over production and quality.
• Secrecy and Control: Requirement for design secrecy or lack of reliable suppliers.
• Workforce Stability: Desire to maintain a stable workforce during periods of declining sales.
• Control Over Lead Time: Desire for control over lead time, transportation, and warehousing.
• Continual Supply Assurance: Assurance of continuous supply and provision of a second source.
• Non-Financial Factors: Political, social, or environmental reasons, and emotional factors like pride.

Considerations Favoring External Procurement

On the other hand, certain factors may lead a company to buy a part externally, including:

• Lack of Expertise: When suppliers' expertise exceeds that of the buyer.
• Cost Considerations: When it's less expensive to purchase the item.
• Small-Volume Requirements: For items with small-volume requirements.
• Limited Production Facilities: Insufficient production facilities or capacity.
• Multiple-Source Policy: Desire to maintain a multiple-source policy.
• Managerial Control: Indirect managerial control considerations.
• Procurement and Inventory Considerations: Factors related to procurement and inventory management.
• Brand Preference: When there's a specific brand preference.
• Strategic Non-Essential Items: Items not essential to the firm's strategy.

Cost Analysis in Make-or-Buy Decisions

Cost and production capacity availability are paramount in make-or-buy decisions, with Burt, Dobler, and Starling emphasizing the importance of thorough cost analysis. This analysis includes various elements for both the "make" and "buy" scenarios, such as incremental costs and follow-on costs related to quality or service. Incremental costs play a crucial role, especially in cases where a firm lacks production capacity or has excess capacity.

Evolution of Decision-Making Methods

Over time, decision-making methods for make-or-buy analysis have evolved. Gardiner and Blackstone introduced the contribution-per-constraint-minute (CPCM) method based on the theory of constraints, while Balakrishnan and Cheng proposed a modified approach using spreadsheets with linear programming capability for complex scenarios. Additionally, firms are increasingly integrating non-price considerations into their decision-making processes through methods like total cost of ownership (TCO) analysis. These developments underscore the growing significance of make-or-buy decisions in shaping manufacturing policies and overall business strategies.

Strategic Considerations in Make-or-Buy Decisions

Senior management often grapple with the make-or-buy decision, seeking to leverage and exploit capabilities within their supply chain. This decision extends beyond mere monetary considerations, as it may involve the procurement or loss of core competencies. Companies must carefully assess how the decision will impact product quality and technological advancement.

Four Stages of Successful Make-or-Buy Decisions

Achieving a successful make-or-buy decision involves four distinct stages:

• Building Incentives for Outsourcing: Creating motivations for considering outsourcing options.
• Exploring Strategic Implications: Evaluating the broader strategic implications of the decision.
• Analyzing Costs and Performance: Conducting thorough cost and performance analyses.
• Selecting Providers: Identifying and selecting suitable providers for the outsourced functions.

Advantages of Make-or-Buy Decisions

Make-or-buy decisions play a crucial role in determining whether to procure materials and parts externally or produce them internally. While this decision can contribute to a company's development, it may not always be the optimal choice in the long term.

Autonomy and Flexibility

Make-or-buy decisions provide companies with autonomy and flexibility, enabling them to choose among multiple options rather than accepting what's readily available in the market. This flexibility allows companies to weigh various considerations, from employee morale to production deadlines.

Financial Considerations

Financial considerations, such as potential cost savings from producing items in-house versus buying them externally, are paramount. While in-house production may increase labor costs, companies need to balance these expenses against potential savings on materials.

Operational Benefits

Make-or-buy decisions also offer operational benefits, such as maintaining a stable workforce during periods of low demand and ensuring timely production to meet tight deadlines. Additionally, by producing materials in-house, companies can exert greater control over product quality, aligning with their specific requirements and enhancing customer satisfaction.

Conclusion

The make-or-buy decision is a critical strategic consideration in logistics outsourcing. It requires a structured and reliable decision-making process tailored to the specific needs and circumstances of each organization. Key steps include assessing the suitability of outsourcing, defining the functions to outsource, setting performance expectations, and selecting the most appropriate providers. Ultimately, these decisions are highly individual and must be made with careful consideration of each company's unique characteristics and objectives.