A make versus buy cost analysis involves comparing all of the costs associated with fulfilling a supply need (making) a good or service in-house against the cost of fulfilling a supply need (buying) a good or service from an outside supply partner. The common factors that companies consider in a make versus buy decision include proprietary knowledge, capabilities, quality, capacity, labor, volume, timing, and cost. Make versus buy analysis should be carefully analyzed at the strategic and operational level of an organization.
At the strategic level, the decision to make or buy a component directly impacts organizational profit, and the firm’s reputation in their industry. In a strategic level analysis, an organization’s leadership should weigh different variables pertaining to the company’s desired business model, competitive environment, governmental regulations, and market trends. At the operational level, the decision to make or buy a component directly impacts operational efficiency, income, and expenses. In an operational level analysis, an organization should weigh out costs considerations, quality control, lead time, transportation, volume, union contracts, and assurance of supply. A strategic make or buy decision will utilize the variables affected at the strategic level and operational level which will lead to a long term sustainable competitive advantage.
When a product is critical to a company’s performance, the use of in-house capabilities to make the product is often a desirable choice. Tight control over the manufacturing process of time sensitive components with frequent design changes are essential to the quality and consistent availability of the product. When a company does not view a product or manufacturing process as a strategic advantage to the business, it is often best to buy the product or manufacturing process from an outside supply partner.
Companies that partner with leading supply partners for non-core goods and services will attain an assortment of advantages such as: reducing unit costs, gaining flexibility to changes in demand, eliminating expenses of capital equipment, attaining access to innovative and alternative process technologies, and de-risking themselves from environmental and governmental regulations. Outsourcing clearly brings strategic and operational benefits to non-core business process when the right strategic partner is chosen. We find the most successful high growth technology companies have developed the ability to strike the optimal balance between vertical and horizontal process integration which allows them to be world-class in all aspects of their business operations whether they make or buy their goods or services.
During a make versus buy analysis it is important that precedent and emotion are taken out of the equation and an objective evaluation is done to determine the final decision. For example, outsourcing a product or process to avoid fixing an inefficient manufacturing process is not conducive to long term operational efficiency. Additionally, electing to maintain a process in-house solely because the capability and capacity already exists may cost an organization more due to the non-core output value. The first steps in conducting a make versus buy analysis should always be to determine if the good or service is critical to the success of the final product, if the good or service requires specialized skills, knowledge, and equipment to produce, or the good or service fits in with the core competencies of the business. Goods or services that fall under any of these categories should always be produced internally if financially and operationally possible.
When management decides a good or service is not crucial to the end product or marketing strategy of the business and supply partners are willing and able to meet the innovative needs and requirements of the supply need, then outsourcing can be a financially and strategically rewarding decision. During the analysis of external suppliers (outsourcing supply partners), companies must examine several key areas of business to assess the capabilities and risk of the supply partner.
These areas can include: manufacturing and engineering capabilities, labor costs, production scaling, capacity utilization, socioeconomic culture, and geopolitical policy. When outsourcing components overseas it is critical to understand and have risk mitigation contingency plans in place as the chances for supply disruption from external factors drastically increase. In addition, once a company has decided to outsource a particular good or service, they must measure the total cost of ownership (TCO) over time to track the financial, operational, and intellectual costs of their decision. Too often, companies outsource business processes to only realize the TCO is a lot greater than performing the process in house and the intangible advantages do not outweigh the added costs of outsourcing.
The decision to outsource business goods or services often has complex implications on the entire organization and should not be made by one single team member or function within the organization. It is imperative that all related functions collaborate to decide on the best strategic and operation choice in the context of the product and business strategy. On a strategic level, outsourcing needs to have the firm’s reputation and core focus in mind while on an operational level, outsourcing needs to be financially suitable and operationally effective. Overall, the benefits from vertical integration can always be optimally counterbalanced by the benefits of using outside best in class supply partners. When executed correctly, a strategic outsourcing program can bring an array of benefits to an organizations short and long-term sustainability and growth.