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The make-or-buy decision involves determining whether to produce an item internally or purchase it from an external supplier. This decision is analyzed at both the strategic and operational levels. Cost and production capacity are typically the most important factors to consider, with firms weighing the internal and external costs of making or buying each part or component. Simple break-even analysis can help identify at what production volume it becomes more cost effective to make or buy a particular item. Total cost of ownership models also incorporate non-price factors into the decision.
The make-or-buy decision involves determining whether to produce an item internally or purchase it from an external supplier. This decision is analyzed at both the strategic and operational levels. Cost and production capacity are typically the most important factors to consider, with firms weighing the internal and external costs of making or buying each part or component. Simple break-even analysis can help identify at what production volume it becomes more cost effective to make or buy a particular item. Total cost of ownership models also incorporate non-price factors into the decision.
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The make-or-buy decision involves determining whether to produce an item internally or purchase it from an external supplier. This decision is analyzed at both the strategic and operational levels. Cost and production capacity are typically the most important factors to consider, with firms weighing the internal and external costs of making or buying each part or component. Simple break-even analysis can help identify at what production volume it becomes more cost effective to make or buy a particular item. Total cost of ownership models also incorporate non-price factors into the decision.
Droits d'auteur :
Attribution Non-Commercial (BY-NC)
Formats disponibles
Téléchargez comme TXT, PDF, TXT ou lisez en ligne sur Scribd
The make-or-buy decision is the act of making a strategic choice between produci
ng an item internally (in-house) or buying it externally (from an outside suppli
er). The buy side of the decision also is referred to as outsourcing. Make-or-bu y decisions usually arise when a firm that has developed a product or partâ or sign ificantly modified a product or partâ is having trouble with current suppliers, or has diminishing capacity or changing demand. Make-or-buy analysis is conducted at the strategic and operational level. Obviou sly, the strategic level is the more long-range of the two. Variables considered at the strategic level include analysis of the future, as well as the current e nvironment. Issues like government regulation, competing firms, and market trend s all have a strategic impact on the make-or-buy decision. Of course, firms shou ld make items that reinforce or are in-line with their core competencies. These are areas in which the firm is strongest and which give the firm a competitive a dvantage. The increased existence of firms that utilize the concept of lean manufacturing has prompted an increase in outsourcing. Manufacturers are tending to purchase s ubassemblies rather than piece parts, and are outsourcing activities ranging fro m logistics to administrative services. In their 2003 book World Class Supply Ma nagement, David Burt, Donald Dobler, and Stephen Starling present a rule of thum b for out-sourcing. It prescribes that a firm outsource all items that do not fi t one of the following three categories: (1) the item is critical to the success of the product, including customer perception of important product attributes; (2) the item requires specialized design and manufacturing skills or equipment, and the number of capable and reliable suppliers is extremely limited; and (3) t he item fits well within the firm's core competencies, or within those the firm must develop to fulfill future plans. Items that fit under one of these three ca tegories are considered strategic in nature and should be produced internally if at all possible. Make-or-buy decisions also occur at the operational level. Analysis in separate texts by Burt, Dobler, and Starling, as well as Joel Wisner, G. Keong Leong, and Keah-Choon Tan, suggest these considerations that favor making a part in-house: * Cost considerations (less expensive to make the part) * Desire to integrate plant operations * Productive use of excess plant capacity to help absorb fixed overhead (usi ng existing idle capacity) * Need to exert direct control over production and/or quality * Better quality control * Design secrecy is required to protect proprietary technology * Unreliable suppliers * No competent suppliers * Desire to maintain a stable workforce (in periods of declining sales) * Quantity too small to interest a supplier * Control of lead time, transportation, and warehousing costs * Greater assurance of continual supply * Provision of a second source * Political, social or environmental reasons (union pressure) * Emotion (e.g., pride) Factors that may influence firms to buy a part externally include: * Lack of expertise * Suppliers' research and specialized know-how exceeds that of the buyer * cost considerations (less expensive to buy the item) * Small-volume requirements * Limited production facilities or insufficient capacity * Desire to maintain a multiple-source policy * Indirect managerial control considerations * Procurement and inventory considerations * Brand preference * Item not essential to the firm's strategy The two most important factors to consider in a make-or-buy decision are cost an d the availability of production capacity. Burt, Dobler, and Starling warn that "no other factor is subject to more varied interpretation and to greater misunde rstanding" Cost considerations should include all relevant costs and be long-ter m in nature. Obviously, the buying firm will compare production and purchase cos ts. Burt, Dobler, and Starling provide the major elements included in this compa rison. Elements of the "make" analysis include: * Incremental inventory-carrying costs * Direct labor costs * Incremental factory overhead costs * Delivered purchased material costs * Incremental managerial costs * Any follow-on costs stemming from quality and related problems * Incremental purchasing costs * Incremental capital costs Cost considerations for the "buy" analysis include: * Purchase price of the part * Transportation costs * Receiving and inspection costs * Incremental purchasing costs * Any follow-on costs related to quality or service One will note that six of the costs to consider are incremental. By definition, incremental costs would not be incurred if the part were purchased from an outsi de source. If a firm does not currently have the capacity to make the part, incr emental costs will include variable costs plus the full portion of fixed overhea d allocable to the part's manufacture. If the firm has excess capacity that can be used to produce the part in question, only the variable overhead caused by pr oduction of the parts are considered incremental. That is, fixed costs, under co nditions of sufficient idle capacity, are not incremental and should not be cons idered as part of the cost to make the part. While cost is seldom the only criterion used in a make-or-buy decision, simple b reak-even analysis can be an effective way to quickly surmise the cost implicati ons within a decision. Suppose that a firm can purchase equipment for in-house u se for $250,000 and produce the needed parts for $10 each. Alternatively, a supp lier could produce and ship the part for $15 each. Ignoring the cost of negotiat ing a contract with the supplier, the simple break-even point could easily be co mputed: $250,000 + $10Q = $15Q $250,000 = $15Q â $10Q $250,000 = $5Q 50,000 = Q Therefore, it would be more cost effective for a firm to buy the part if demand is less than 50,000 units, and make the part if demand exceeds 50,000 units. How ever, if the firm had enough idle capacity to produce the parts, the fixed cost of $250,000 would not be incurred (meaning it is not an incremental cost), makin g the prospect of making the part too cost efficient to ignore. Stanley Gardiner and John Blackstone's 1991 paper in the International Journal o f Purchasing and Materials Management presented the contribution-per-constraint- minute (CPCM) method of make-or-buy analysis, which makes the decision based on the theory of constraints. They also used this approach to determine the maximum permissible component price (MPCP) that a buyer should pay when outsourcing. In 2005 Jaydeep Balakrishnan and Chun Hung Cheng noted that Gardiner and Blackston e's method did not guarantee a best solution for a complicated make-or-buy probl em. Therefore, they offer an updated, enhanced approach using spreadsheets with built-in liner programming (LP) capability to provide "what if" analyses to enco urage efforts toward finding an optimal solution. Firms have started to realize the importance of the make-or-buy decision to over all manufacturing strategy and the implication it can have for employment levels , asset levels, and core competencies. In response to this, some firms have adop ted total cost of ownership (TCO) procedures for incorporating non-price conside rations into the make-or-buy decision. SEE ALSO: Break-Even Point R. Anthony Inman FURTHER READING: Balakrishnan, Jaydeep, and Chun Hung Cheng. "The Theory of Constraints and the M ake-or-Buy Decision: An Update and Review." Journal of Supply Chain Management: A Global Review of Purchasing & Supply 41, no. 1 (2005): 40â 47. Burt, David N., Donald W. Dobler, and Stephen L. Starling. World Class Supply Ma nagement: The Key to Supply Chain Management. 7th ed. Boston: McGraw-Hill/Irwin, 2003. Gardiner, Stanley C., and John H. Blackstone, Jr. "The 'Theory of Constraints' a nd the Make-or-Buy Decision." International Journal of Purchasing & Materials Ma nagement 27, no. 3 (1991): 38â 43. Wisner, Joel D., G. Keong Leong, and Keah-Choon Tan. Principles of Supply Chain Management: A Balanced Approach. Mason, OH: Thomson South-Western, 2005.