Managing Supply Chains in Africa: Make-or-Buy Decision

Make-or-buy decision analysis is an integral part of an organization’s strategic planning that helps them stay in business and profitable during market demand uncertainty, declining organization capability, and difficulties with suppliers. A make-or-buy decision is an act of choosing between manufacturing a product in-house or purchasing it from an external supplier. It compares the costs and benefits associated with producing a necessary good or service internally, to the costs and benefits involved in hiring an outside supplier for the resources in question. Service-based businesses analyze the cost of providing a service versus outsourcing.

To compare costs accurately, a company must consider all aspects regarding the acquisition and storage of the items versus manufacturing the items in-house, which may require the purchase of new equipment, as well as storage costs. It also includes all the transaction costs involved in creating the product or service, extra labour needed for production, monitoring costs, and waste product disposal costs resulting from the production process. Similarly, businesses must focus on both the production and transaction costs when considering outsourcing from outside suppliers. For example, the product’s price, sales tax charges, and shipping costs must be factored in. Inventory holding costs, which comprise warehousing and handling costs, as well as risk and ordering costs, must also be included.

Factors Influencing a “Make” Decision

Factors that may influence a firm towards making an item in-house rather than outsourcing include:

1. Cost concerns. When buying from outside sources is expensive, organizations opt for in-house production.
2. Desire to focus on manufacturing. Organizations intending to venture into manufacturing will select the “make” decision.
3. Intellectual property concerns. The costs required to acquire a patented product may be high.
4. Quality concerns. The quality of the product cannot be compromised.
5. Unreliable suppliers. Mostly, businesses have doubts about the reliability of outsourcing partners. These doubts lead to in-house production.
6. Quality control requirements. When an organization carries out production activities, they have control over product quality. But when they outsource a part of the production, they do not control the product quality. Therefore, in-house production is the best option for the best quality control.
7. Emotional motives. It’s very easy for this factor to be overlooked. A company can manufacture a product based on emotional responses such as pride or contempt instead of logical reasoning.
8. Transportation costs. Sometimes, transportation costs play a key role in the make-or-buy analysis. Unstable and high transportation costs can lead businesses to in-house production.

Other factors that influence a “make” decision include:

• Environmental considerations
• Political considerations
• Absence/shortage of competent suppliers
• Insignificant volume for a prospective supplier
• Preservation of a backup source

Factors Influencing a “Buy” Decision

Factors that may influence a firm’s decision to buy a part rather than produce it internally include:

• Lack of expertise. Outsourcing is the best choice when a business lacks the skills for manufacturing a product. Suppliers with expertise can offer the product at a cheaper price. Therefore, the “buy” option is best for a business.
• Cost considerations. Businesses outsource when manufacturing a product or providing a service is expensive.
• Lack of facilities. Outsourcing is better when the business lacks facilities or capacity, equipment, resources, etc.
• Low demand quantity. For smaller quantities, businesses can go for a “buy” decision.

Other factors that influence a “buy” decision include:

• Research and specialized know-how of the supplier better than the buyer
• De-Risking the sourcing
• Procurement and inventory considerations
• Product or service isn’t essential to the firm’s strategy
• Brand preference

Advantages of a Make-or-Buy Decision

If a company is already in business, there may be a point when certain situations arise that will cause a company to pause and consider which direction it should proceed in, that is, whether it should manufacture its own products or outsource from a supplier. Some of these events could be a trusted supplier shutting down, an increase or decrease in demand for the product, or a possible path for new opportunities. At these junctions, management will have to consider the advantages of either making or buying the product, which can also be outside of a cost-benefit analysis. Will one decision lead to economies of scale, a possible new product line, or a restructuring of the core business? Depending on the business and its place in the market, there will be both advantages and disadvantages of continuing down the same path or forging a new one. Some benefits of make-or-buy decision analysis include:

• Lower Costs: Make-or-buy decisions seek cost-effective methods in providing a product or service. Therefore, whether a business chooses to make goods or subcontract production to a third party, using a make-or-buy decision method can reduce prices and increase profitability.
• Access to New Resources: Organizations can use profits from make-or-buy decisions to expand the business and gain new resources.
• Helps in Strategic Planning: Businesses must investigate both their internal and external environments to receive the benefits. This is an important decision, and its outcome shapes the organization’s strategic planning. In particular, the culture in which such decisions are reached, and the agenda of the parties involved can influence the decisions and their implementation, as well as the sustainability of the policy.
• Unnecessary Mistakes are Avoided: Make-or-buy decisions help businesses find the most viable alternative to clients with knowledge of their capacities. Mistakes happen when businesses take on more than they can handle, and a make-or-buy decision helps avoid this.
• Competitive Advantage: A make-or-buy analysis assists businesses in gaining a competitive advantage. A business can focus on its core activity and outsource the rest. It helps them reduce costs and offers consumers a better product at a reduced price. It is a competitive advantage. Such a company is better placed to weather the storm of a market downturn.

Lastly, the make-or-buy decision should be taken with utmost care keeping the long-term and short-term benefits into consideration. The primary motivators for a make-or-buy decision are cost and quality concerns. The make-or-buy decision is sometimes treated as a financial or accounting decision. While it is important to conduct an accounting assessment and settle for the low-cost approach, it is crucial to understand the basis of the decision. Therefore, companies must consider the strategic dimension of make-or-buy choices because they determine the profitability of the company and play an important role in its financial health. Most of all, they can impact the corporate strategy, core competence, cost structure, customer service, and flexibility.

Article by Michelle Nthemba

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