Make or buy decision
| Make or buy decision |
|---|
| See also |
Make or buy decision is decision to choose between internal and external exchange. The company decides to make or buy decision for a specific activity by balancing the costs of external transactions with the internal transaction costs associated with this activity. The basic guidelines in the selection are, for example, price, competition, lack of capacity or its shortage or the need to increase the responsiveness. Decisions regarding the total cost of purchase, complexity, technology and skills are taken into account[1][2][3].
"The decision to make or buy extends beyond manufacturing, encompassing human resources, information technology, maintenance, and other fundamental business functions"(Schwarting D., Weissbarth R.(2011))[4].
Make or buy decision is related to quality problems, cost considerations, sales fluctuations, introduction of new products, modification of existing or unsatisfactory supplier results. The company must make more objective and informed decisions, therefore the choices are made after high-level discussions. The developed strategy simplifies the decision which is based on three pillars such as the business strategy, risk and economic factors
Business strategy
"Business strategy includes the strategic importance to the company of the product or service that is being considered for outsourcing, as well as the process, technologies, or skills required to make the product or deliver the service. "(Schwarting D., Weissbarth R.(2011))[5]
This is a good choice when the company strives to eliminate charges, reduce costs. Giving the company the flexibility to change the demand , access to new technologies.[6].
Risks
Threats include lower quality, predictability of outsourced solutions compared to internal production or services. In the case of many suppliers, a single failure of the supply chain may not be tragic. When suppliers produce components instead of finished products, production errors can be detected during production.
The concept of improving the functioning of enterprises, leads to a reduction in costs by using services, semi-products offered by an external manufacturer. According to the economics of transaction costs, the company will decide to outsource based on a reduction in production and transaction costs. Production costs refer to the direct costs associated with the production of a product or service and include labor and infrastructure costs. Transaction costs include, among others, costs related to the selection of suppliers, contracts or monitoring of results. The risks associated with outsourcing should be assessed, regardless of whether it is related to the supply chain or proprietary technologies and intellectual property. It is often an emotional reaction, a way to avoid repairing processes that have become ineffective and real potential is not understandable. It may be a poor alternative to confronting internal inefficiencies and improving the company's performance[7] [8].
Economic factors
They include the impact of outsourcing on capital expenditures, return on invested capital and possible savings obtained from outsourcing. The basis is to identify the supplier's costs and design a price setting mechanism that will reflect current costs and how they may change in the future.[9].
Footnotes
References
- Klein P.G.(2005).The Make-or-Buy Decision: Lessons from Empirical Studies.Handbook of New Institutional Economics, Springer, Netherlands.
- Norman G., Chisholm D. C.(2014).Dictionary of Industrial Organization.Edward Elgar Pub, Cheltenham, UK. Northampton, MA.
- Schwarting D., Weissbarth R.(2011).Make or buy: Three pillars of sound decision making. Booz & Company, Düsseldorf.
- Sillanpää I.(2015).Strategic decision making model for make or buy decisions. Article in International Journal of Logistics Economics and Globalisation, Vaasa, Finland.
Author: Anna Korzeń
