Make or buy decision

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.

"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)).

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))

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.

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 .

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.

Examples of Make or buy decision

• Manufacturing: A company may decide to manufacture a particular product internally or outsource it to an external vendor. The decision will depend on factors such as the cost of production, the availability of the raw materials, the expertise of the internal workforce, and the cost of purchasing the finished product from an external source.
• Software Development: Companies may decide to develop their own software or outsource the software development to an external vendor. The decision will depend on factors such as the cost of development, the expertise and experience of the internal team, and the cost of purchasing the software from an external source.
• Marketing: Companies may choose to outsource their marketing activities or to do them internally. This decision will depend on factors such as the cost of hiring an external marketing firm, the expertise and experience of internal marketing personnel, and the cost of purchasing advertising.

Advantages of Make or buy decision

A make or buy decision is a strategic decision by a company to decide whether a certain activity should be done internally or externally. There are many advantages of making this decision as it can help a company save costs, increase efficiency, and become more competitive in the market. The following are some of the advantages of making a make or buy decision:

• Cost Savings: By outsourcing certain activities, a company can often save money due to reduced labor costs, access to cheaper materials, and the ability to purchase in bulk.
• Increased Efficiency: By outsourcing certain activities, a company can increase the efficiency of operations by focusing on core competencies.
• Access to Expertise: By outsourcing certain activities, a company can access expertise and resources that may not be available or affordable internally.
• Increased Flexibility: By outsourcing certain activities, a company can quickly adjust to changing market conditions and customer needs.
• Improved Quality: By outsourcing certain activities, a company can benefit from higher quality materials and services.
• Reduced Risk: By outsourcing certain activities, a company can reduce the risk associated with certain activities, such as product development or research and development.

Limitations of Make or buy decision

Make or buy decisions can be limited in many ways. These limitations include:

• The cost of the external purchase may not accurately reflect the total cost of the activity. This may be due to uncertainty in the market, lack of information or inexperience of the decision makers.
• There may be externalities associated with the activity that are not taken into account when making the decision. These could include environmental, social or reputational costs.
• The decision may be made without considering the time trade-off associated with the activity. This could lead to a decision that ignores the need for rapid decision making or the need to meet tight deadlines.
• The decision may be affected by the biases and preferences of decision makers. This could lead to decisions that are not based on rational economic principles.
• The make or buy decision may be affected by the availability of resources. If the resources needed to make the product or service are not available, then the company may be forced to buy from an external source.

Other approaches related to Make or buy decision

Make or buy decision involves taking into account a range of different approaches and considerations. These include:

• Cost-benefit analysis: This approach focuses on cost and benefit comparison between the external and internal sources. It takes into account both the short-term and long-term cost and benefit implications.
• Quality: This approach focuses on the quality of the product or service that is being produced. It evaluates the quality of the external and internal sources, and then decides which one is better.
• Risk: This approach focuses on the risks associated with the external and internal sources. It evaluates the potential risks of relying on external sources and the potential risks of relying on internal sources.
• Technology: This approach focuses on the technology of the external and internal sources. It evaluates the technology of the external and internal sources and then decides which one is better.
• Time: This approach focuses on the time needed for the production or delivery of the product or service. It evaluates the time needed for the external and internal sources and then decides which one is better.

In conclusion, make or buy decision requires a careful evaluation of different approaches, such as cost-benefit analysis, quality, risk, technology, and time. This evaluation must be done to determine which source is more cost effective and reliable in terms of quality, risk, technology, and time.

Footnotes

Make or buy decision — recommended articles

Make-Or-Buy Decision — Target cost — Cost advantage — Cost behavior — Operational decision — Rating process — Factor of production — Low cost strategy — Designed quality

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