MAKE OR BUY, INSOURCING/OUTSOURCING

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Analysing Strategic Outsource Decisions

Option to make or buy is first presented atthe beginning of product life cycle duringnew product development.

Vertical integration to make or in sourcematerial can affect cost, flexibility andresponsiveness.

Lean manufacturing (lean firmsincreasingly buy more and make less)mindset is the current trend.

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Analysing Strategic Outsource Decisions

Deal first with Subsystems of the Products

No Outsource Is it Strategic ?

Yes Further Analysis Required

Deal Next with components and parts that make up the strategic Subsystem.

Can the subsystem be No Make In-house Broken down into Families of components Are families of NO outsourceAnd parts? components and

Parts Strategic Yes Make in-house

Analysing Strategic Outsource Decisions

Outsource subsystems and components unless they fall intofollowing categories.

a) Item that is critical to success of the product, includingcustomer perception of important product attributes,

b) An item that requires specialised design andmanufacturing skills or equipment and the number

of capable and reliable supplier is extremely limited.

c) Any item that fits well within the core competencies orwithin those the firm must develop to fulfill further plans.

Relative costs and volume requirement is also aconsideration despite core competencies.

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Reasons for Make Instead of Buy

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• The quantities are too small and/or no supplier is interested or available in providing the goods.

• Quality requirements may be so exacting or so unusual as to require special processing methods that suppliers cannot be expected to provide.

• There is greater assurance of supply.

• It is necessary to preserve technological secrets.

• It helps the organization obtain a lower cost as the purchase option is too expensive.

• It allows the organization to take advantage of or avoid idle equipment and/or labour.

• It ensures steady running of the corporation’s own facilities, leaving suppliers to bear the burden of fluctuations in demand.

Reasons for Make Instead of Buy

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• It avoids sole-source dependency.

• Competitive, political, social or environmental reasons may force an organization to make even when it might have preferred to buy

• The distance from the closest available supplier is too great.

• A significant customer required it.

• Future market potential for the product or service is expanding rapidly and forecasts show future shortages in the market or rising prices.

• Management takes pride in size.

Reasons for Buying Outside

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• The organization may lack managerial or technical expertise in the production of the items or services in question.

• The organization lacks production capacity.

• Certain suppliers have built such a reputation for themselves that they have been able to build a real preference for their component as part of the finished product.

• The challenges of maintaining long-term technological and economic viability for a noncore activity are too great.

• A decision to make, once made, is often difficult to reverse.

• It assures cost accuracy.

• There are more options in potential sources and substitute items

Reasons for Buying Outside

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• There may not be sufficient volume to justify in-house production.

• Future forecasts show great demand or technological uncertainty an d the firm is unable or unwilling to undertake the risk of manufacture.

• A highly capable supplier is available nearby.

• The organization desires to stay lean.

• Buying outside may open up markets for the firm’s products or services.

• It provides the organization with the ability to b ring a product or service to market faster.

• A significant customer may demand it.

• It encourages superior supply management expertise.

Considerations Which Favour Making

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• Cost considerations (less expensive to make the part)

• Desire to integrate plant operations.

• Productive use of excess plant capacity to help absorb fixed overhead.

• Need to exert direct control over production and/or quality.

• Design secrecy required.

• Unreliable suppliers.

• Desire to maintain a stable work force (in periods of declining sales).

Considerations Which Favour Buying

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• Limited production facilities

• Cost considerations (less expensive to buy the part)

• Small volume requirements

• Suppliers’ research and specialized know-how.

• Desire to maintain a stable work force (in periods of rising sales).

• Desire to maintain a multiple source policy.

• Indirect managerial control considerations.

• Procurement and inventory considerations.

Determination of the cost to Make or Buy

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Cost considerations indicate that a part should be made in-house; in others, they dictate that it should be purchased externally. A make-or-buy cost analysis involves a determination of the cost to make an item – and a comparison of this cost with the cost to buy it.To Make • Delivered purchased material costs.• Direct labour costs.• Any follow-on costs stemming from quality and related problems.• Incremental inventory carrying costs.• Incremental factory overhead costs.• Incremental managerial costs. • Incremental purchasing costs.• Incremental costs of capital.To Buy• Purchase price of the part.• Transportation costs.• Receiving and inspection costs.• Incremental and inspection costs.• Any follow-on costs related to quality or service.

INSOURCING

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Insourcing refers to reversing a previous buy decision. An organization chooses to bring in-house an activity, product, or service previously purchased outside.

Insourcing, the often forgotten twin of outsourcing, deals with past buy decisions that are reversed. The most obvious reasons are 1. when an existing source of supply goes out of business or drops a product or

service line and no other supplier is available

2. Sudden massive increase in price, the purchase of a sole source by a competitor, political events and regulatory changes, or a lack of supply of a key raw material or component required for the manufacture of the purchased product might force supply to consider insourcing

3. May have developed a unique process for this product or service and as a result quality, delivery, total cost of ownership, or flexibility would be vastly improved and provide superior customer service and satisfaction.

Insourcing would greatly enhance competitive ability.

With any insourcing initiatives, there is also a new supply issue in terms of raw materials, components, equipment, energy, and services required to produce the particular requirement just insourced.

Outsourcing

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Outsourcing reverses a previous make decision. Thus an activity, product, or service previously done in-house will next be purchased.

Almost no function is immune to outsourcing. The growth in outsourcing in the logistics area is attributed to transportation deregulation, the focus on core competencies, reductions in inventories, and enhanced logistics management computer programmes.

The reasons for outsourcing are similar to those advanced for the buy option in make-or-buy decisions. There is a key difference. “What happens to the employees and space and equipment previously dedicated to this product or service now outsourced

?”

Outsourcing

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Additional concerns over outsourcing include:-• Loss of control • Exposure to supplier risks: financial, weakness, loss

of supplier commitment. Slow implementation, promised features or services not available, .responsiveness, poor daily quality.

• Unexpected fees or “extra use” charges• Difficulty in qualifying economics.• Conversion costs• Supply restraints• Attention required by senior management• Possibility of being tied to obsolete technology• Concerns with long-term flexibility and meeting

changing business requirements.

OUTSOURCING PURCHASING AND LOGISTICS

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Purchasing function has also come under scrutiny in some organisations as a target for outsourcing.

Many tasks associated with the logistics function as well as the entire function itself have been heavily outsourced.

The outsourcing decision is a function of many factors, and each organisation must assess these factors based on the goals and objectives and long-term strategy of the organization. The more skilled the supply group at exploiting market opportunities and developing competitive sources, the more readily the organization should be to buy outside and outsource.