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Strategic Make or Buy Decision Methodology for Achieving

Competitive Advantage

Kiwon Lee*, Euiho Suh**, Daegeun Hong***

Department of Industrial and Management Engineering

Pohang University of Science and Technology (POSTECH)
77 Cheongam-ro, Nam-gu, Pohang, Gyungbuk, Korea, 790-784*,**,***

Abstract ing. This helps companies to be more flexible in re-

sponding to the global competition environment.
Make or Buy decision is becoming increasingly im- Strategic sourcing, that is, Make or Buy is becoming
portant as firms are globalized with branch plants the main issue of the business in order to achieve
around the world. In most cases, the decision making competitive advantage [7, 19].
mainly depends on the cost analysis in terms that how Make or Buy decision is the act of making a
we can make the products cheaper. However, for strategic choice between producing an item internally
gaining companys future compatibility, it is needed (in-house) or buying it externally (from an outside
to consider not only cost aspect but also technology supplier) [5]. However, previous studies on Make or
aspect and product operation ability from a company Buy mainly discussed the production cost to gain
view. In this sense, previous researches mentioned competitive price of companies [16]. In most cases,
importance and factors of the technological and oper- the decision making mainly depends on the cost anal-
ational aspect theoretically, but they are insufficient ysis in terms that how we can make the products
to apply the Make or Buy decision process in practice. cheaper. When the Make or Buy is only analyzed
Therefore, this paper describes a systematic method- from the production cost perspective, companies of-
ology for Make or Buy decision to achieve compa- ten fall into the trap of a short-term profit instead of
nys competitive advantage. The proposed methodol- core competence.
ogy consists of three perspectives: technological, In this sense, Welch and Nayak [19] suggested a
financial, and operational perspective. A case study of Make or Buy decision model considering financial
Company A, home appliance manufacturer, is per- and technological aspects at the same time. Sislian
formed to prove the effectiveness of the proposed and Satir [16] also developed a model of Make or
methodology. Buy decision including finance analysis and produc-
Keywords: Make or Buy Decision, Quality Function tion analysis. Previous researchers mentioned im-
Deployment, Patent Portfolio Analysis, Total Cost portance and factors of the technological and opera-
Analysis, Optimal Production tional aspect theoretically, but they are insufficient to
apply the Make or Buy decision process in practice.
1. Introduction For gaining companys future compatibility, it is
needed to consider not only cost aspect but also tech-
Recently, companies strategically use external nology aspect and product operation ability from a
resources not only to reduce their expenditures but company view [14].
also to maximize their manufacturing efficiency. Uti- Therefore, this paper describes a systematic
lizing external resources is called to be an outsourc- methodology for Make or Buy decision to achieve

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companys competitive advantage. The proposed [10] developed conceptual Make or Buy decision
methodology consists of three perspectives: techno- making framework based on firms core capability
logical, financial, and operational perspective. In and cost factors. Winer et al. [20] interpreted Make or
technological perspective, Make or Buy decision of Buy issue through cost, necessity of using firms
the product is evaluated through QFD and patent overproduction, stability of procurement, and degree
portfolio analysis. In financial perspective, Make or of expertise process technology. Sislian and Satir [16]
Buy decision of the product is evaluated by Total suggest technological position, demand fluctuation,
Cost of manufacturing. In operational perspective, manufacturing capability, process maturity, and out-
optimal production is considered in Make or Buy sourcing risk as factors for evaluating Make or Buy
decision. Based on the results of three perspectives, decision.
guidelines of the Make or Buy decision are developed. When concluding Make or Buy decision, vari-
ous perspectives and factors for evaluating Make or
2. Literature review Buy have to be considered [14]. As the previous re-
searches indicated, major factors to consider in Make
2.1. General concept of Make or Buy decision or Buy decision are largely discussed in three per-
Product manufacturing process is generally di- spectives; technological, financial, and operational
vided into two types in terms of who produces prod- perspective. Therefore, in order to support Make or
ucts or items: Make and Buy [17, 18]. Make is a Buy decision effectively and elaborately, methodolo-
manufacturing type that a company produces items or gy for Make or Buy decision through integrated and
components of the product by using its own in-house balanced approach with technological, financial, and
capabilities or functions. Make originally meant the operational perspectives is needed.
activity for manufacturing something inside of the
firm. On the other hand, buy is a manufacturing type 2.2. Make or Buy decision making in financial per-
that a company entrusts some of its internal activities spective
to outside suppliers [5]. Nowadays, firms tend to out- Companies traditionally regarded manufacturing
source their functions and activities for the purpose of cost as the most important factor in Make or Buy
cost reduction, concentration to core competency or decision making [2]. For this reason, initial Make or
mass production, and action for demand fluctuation Buy decisions were dealt with economic approach
[10]. Outsourcing activity has been used for keeping mainly based on the Transaction Cost Theory, which
competitive advantage of the firm in flexible supply is accounting for the actual cost of outsourcing pro-
of products. duction of products or services including transaction
Make or Buy decision indicates a strategic costs, contracting costs, coordination costs, and
choice between internally possessing fundamental search costs [11, 12, 15]. Although the economic ap-
functions or services for producing products and pur- proaches are analyzed based on the long-term goal
chasing functions or items from external providers for gaining firms competitiveness in a broad per-
[5]. Past Make or Buy choice was a traditional simple spective, many of previous researches approaches
question in business management [3], but as previous mainly focused on the problem solving in short-term
product and service market has been shifted to the view.
global market, Make or Buy decision making process Besides, a firms Make or Buy decision in fi-
is becoming an important issue for not only achieving nancial perspective are analyzed by calculating man-
firms competitive advantage but surviving in fierce ufacturing cost in terms of the cost per each item unit
competition on global environment [7, 9, 17, 19]. supplied in general. Unit cost concept has an ad-
With the importance of Make or Buy decision vantage to simply expect product cost with produc-
making, researches on the factors to consider in Make tion quantity, but it also has a disadvantage to distrib-
or Buy decision are conducted in many ways. Welch ute indirect cost in manufacturing product or items.
and Nayak [19] emphasized the technological aspect That is, fixed costs which are required in manufactur-
for firms competitive advantages through importance ing and cant follow the detail breakdowns of the
and maturity of process technology. Maclvor et al. total expenditure directly are not able to allocate their

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costs into the unit cost exactly. Due to the limitation volatility of demand and productive capacity are re-
of distribution of indirect cost, a firm can take wrong flected for the productive perspective in the previous
decision of buy, despite it has a surplus asset or capa- researches about Make or Buy decision making.
bility. In this sense, Burt et al. [1] insisted that all However, there are the limitations for previous re-
manufacturing related costs be included in Make or searches that only qualitative approaches are applied
Buy decision when considering financial perspective. for decision making. Making sophisticated decision
A distinctive feature of manufacturing products making process is needed when qualitative and quan-
or items compared to buy them is the investment of titative approaches for decision making are balanced.
facilities or infrastructure for making them. If a firm Now days, In order to achieve the company's
decides to make products or items, deservedly it has competitive advantages by improving a company's
to invest money to construct a factory or set up facili- future competitiveness and maximizing the manage-
ties for making products or items. Short-term manu- rial flexibility and efficiency in the global unlimited
facturing cost analysis cant fully reflect the effect of competition environments, not only financial ap-
investment, so it leads not to compare benefits be- proach but also technological and productive ap-
tween Make and Buy. Therefore, it is necessary to proaches are needed for Make or Buy decision mak-
consider investment cost and to conduct financial ing [10, 13]. If the approaches of decision making are
analysis in terms of long-term and total cost view. overly weighted toward one side, the decision making
2.3. Make or Buy decision making in the Technologi- would be interrupted by the distortion of information.
cal and Productive perspectives A company should conduct the decision making in
In technological perspective, a company should the synthetic perspectives based on the balanced vi-
decide Make for components and all functions related sion because Make or Buy decision making is not for
to the technologies that will be the core technologies the short-term responses, but for long-term planning
for the future companys competitiveness based on of the future strategy for companys management
the importance of manufacturing technology, tech- policy. In other words, a new methodology which can
nologys maturity, and manufacturing capability [8]. practically imply the companys conditions consid-
Probert [13] presented the optimal outsourcing strate- ered financial, technological and productive aspects
gic selection introduced the 3 by 3 matrix of a tech- is needed for the Make or Buy decision making.
nological competitiveness and technological im-
portance for the defining the company's core technol- 3. Methodology
ogies. Welch and Nayak [19] also introduced the 3 by
9 matrix for the classification of the company's tech- The suggested methodology for Make or Buy
nologies in the manufacturing strategic perspective. decision is shown in Figure 1. There are four stages:
Make or Buy decisions are made by the reflecting the technological perspective, financial perspective, op-
technologies to 3 by 9 matrix in terms of the technical erational perspective, and guidelines of decision mak-
competitive advantage, technology maturity and ing.
technical importance.
In the productive perspective, a company needs
to find the optimal Make points for boosting the effi-
ciency of production to the maximum considered the
manufacturing capacity of a company [4]. Sislian and
Satir [16] presented the methodology of Make or Buy
decision making in the form of flowchart for strategic
outsourcing. Make or Buy decisions are made by the
volatility of demand and productive capacity of part-
ners, targets for outsourcing in flowchart.
Thus, the technological competitiveness, techno-
logical maturity and technological importance are
considered for the technological perspective and the Figure. 1. Make or Buy Decision Research

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3.1. Step1: technological perspective represents the trend of patent moves caused by the
3.1.1. Analysis of Technology Importance general patenting activity [6].
QFD offers casual connection between custom- Maturity of technology is interpreted based on
ers requirements and engineering characteristics. this general patenting activity, and the stages are clas-
The customer requirements are considered to be input sified into four stages according to the patent portfo-
parameters; whereas the items or processes are con- lio. Growth period is that the technology is intro-
sidered as output parameters. This application high- duced, so it increases both application and applicant
lights the consideration of different processes and in this period. Development period is the technology
items to see which are best suited to each diverse is on the rapid growth of R&D, and also it increases
company. By using QFD in this study, a company both application and applicant rapidly. Maturity peri-
needs to consider the actual customer requirements od is that the technology is on the stable stage, and
and then, match the best suited processes or items. trend shows stagnant or decrease in application and
So in this study, the typical QFD processes used applicant. Finally, Decline period is the technology is
in various applications are customized to select key decrease in application and applicant due to introduc-
processes and items. The proposed application of 1st tion of alternative technology. In this study, technolo-
QFD is to examine the choices of item importance gy maturity stage is classified only into
against the requirements of a product. In 2nd QFD, growth/development period or maturity/decline peri-
the choice of process importance against the key od in larger concept of maturity.
items selected in the 1st QFD is analyzed. Figure 2
represents the elements of HOQ for this application.
Item 1 Item 2 Item 3 Item n
Tech. 1 Tech. 2 Tech. 3 Tech. k
C.R. 1 Key Item

C.R. 2 Item 1

C.R. 3 Item 3
: Item n

C.R. m Technology

Key Item Key Process

Item 1
Item 3
Tech. 1 Figure 3. Patent Portfolio-Based Technology
Item n
Tech. 3
Maturity Analysis
Figure. 2. 1st and 2nd QFD: C.R.-Item and
Item-Process Relationship Analysis
3.1.3. Matrix of Technology Strategy

3.1.2. Analysis of Technology Maturity

Rising Key Saturated Key
The basic concept of patent portfolio as a type of Technology Technology

the patent analysis is the tool for analyzing the stages Technology

of development of a particular technology based on Low

Non-Key Non-Key
Technology Technology
the patterns in patenting activity [21]. A general mod-
el for patenting activity can be established to under- Growth/Development Maturity/Decline
Period Period
stand maturity of the technology through the number Technology
of patent applicants and patent applications. Technol-
ogy maturity of each process technology is carried Figure 4. Matrix of Technology Strategy
out through the patent portfolio.
As plotting the bubbles on the patent portfolio A matrix of technology strategy consists of two
which consists of two axes, the number of patent ap- axes: technology importance and technology maturity.
plicants and patent applications, technology maturity It can assist the Make or Buy decision-making as
is defined. Bubble sizes represent the number of ap- shown in Figure 4. In this matrix, when a process
plications, calculating the ratio of the number of ap- technology is high in the technology importance and
plications in particular period per total number of is located on growth/development period in the tech-
applications and the number of applicants in particu- nology maturity view, it is basically decided Make.
lar period per total number of applicants. Figure 3 The other cases are concluded with Buy. However,

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when a process technology is high in the technology In using Make mixed with Buy condition, the
importance, even if it is located on maturity/decline optimum production of Make and Buy is calculated at
period in the technology maturity, financial analysis a specific production planning. In the Figure 5, the
will be additionally performed in the next step. Make decision can reduce total cost by buying some
items at the point of additional investments by the
3.2. Step2: Financial perspective increase of production.
Processes assigned to Make in the matrix of
technology strategy are conducted with total cost 3.4. Step4: Guidelines of Decision Making
analysis and manufacturing cost analysis. This study Make or Buy decision of processes and items is
is premised on the assumption that a company makes suggested based on the analysis of three perspectives:
a production planning based on demanding forecast- technology, finance and operation. Guidelines of de-
ing of a product. cision making on make or buy is presented in 3 by 3
3.2.1. Manufacturing Cost Analysis matrix form, Make or Buy Decision Support Matrix
The manufacturing cost is meant the cost of pro- (Figure 6). This guideline framework can support
ducing a product or item in a company during a spe- users to decide Make or Buy effectively. It consists of
cific period. In Make case, the manufacturing cost is technological guidelines axis (rising key technology,
added all the primary cost, for example, material cost, saturated key technology, non-key technology) and
labor expenses, capital expenditures, etc. In Buy case, financial and operational guidelines combined con-
the manufacturing cost is calculated the cost of pur- cept of two perspectives (advantageous for make, buy,
chasing a product or item externally. Figuring out and mixing make and buy).
Make cost and Buy cost during a specific period
through the manufacturing cost analysis assists the
Make or Buy decision-making as shown in Figure 5.
In this figure, Make or Buy section is decided by the
primary cost characteristics such as fixed cost and
variable cost, and a number of production planning.
3.2.2. Total Cost Analysis
In this study, Total cost is meant that the total
amount spent on a particular cost, including the price
of the investment itself, plus commissions, fees, other
Figure 6. Make or Buy Decision Support Matrix
transaction costs, and taxes. In other words, it in-
cludes the sum of fixed costs, variable costs, and
4. Case Study
semi-variable costs during a specific period. Make or
Buy decision-making is performed by using invest-
Company A is global company which is setting
ment economic feasibility with calculated total costs
up local corporations in various countries and pro-
of Make and Buy.
ducing home appliances. Company A has made stra-
tegic use of item sourcing from foreign corporations
3.3. Step3: Operational Perspective
and partner companies in local area in order to reduce
manufacturing cost and investment risk, and enhance
flexibility of in-house production line. However,
Company A performed assembly and inspection pro-
cess, relatively non-value-added works, it didnt have
core process in-house for growth, and worried about
the situation that Company As capability itself has
been declined. Thus, in order to procure its competi-
Figure 5. Total Costs of Make and Buy According to
tiveness in the future and the world, Company A is
Production Quantity
planning to reorganize the current Make or Buy for-
mation of each process by establishing the standards

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of the optimum production through the Make or Buy ure 7. Thus, technology maturity of SMT is conclud-
decision methodology in this paper. ed that process A (SMT) is on the
growth/development period.
4.1. Step1: Technological perspective in Company A
4.1.1. Analysis of Technology Importance
In the analysis of technology importance of
Company A case, customer requirements of As air
conditioner are derived and items for consisting of
the air conditioner are listed. Based on the customer
requirements the items, key items are selected
through the QFD. In this case study, items which can
be purchased from the outside easily and are under 1% Figure 7. Patent Portfolio of Process A (SMT)
of the cumulative cost in the air conditioner such as
sticky tape, bolt, nut, etc. is filtered out of this analy- 4.2. Step2: Technological perspective in Company A
sis. Furthermore, 2nd QFD is skipped because of the Analysis in financial perspective is simulated by
intuitive relationship between key items and their Microsoft Excel application. Excel-based manufac-
process. turing cost simulation program is developed in order
After analyzing technology importance in Com- to support Make or Buy decision to decision makers
pany A case through QFD, three manufacturing pro- easily in practical. Besides, due to the security policy
cesses (A, B, C) of eight (A, B, C, D, E, F, G, H) are of the Company A, the result of analysis in financial
concluded into key processes. Due to the security perspective in this paper is shown to virtual cost data
policy of the Company A, name of the manufacturing and quantity not actual data.
processes is concealed but named it process A to H. In manufacturing cost analysis of process A
One of the key processes in this case is SMT (Surface (SMT), total cost for making the items manufactured
Mount Technology), process A. SMT is a technology through SMT, virtually named SMTpart1, SMTpart2,
for constructing electronic circuits in which the com- and SMTpart3, is analyzed. The simulation program
ponents are mounted directly onto the surface of calculates and represents the total cost both making
printed circuit boards. This paper introduces the case SMTpart1, SMTpart2, and SMTpart3 and buying in
focused only on the SMT, process A. determined production quantity.
4.1.2. Analysis of Technology Maturity First of all to calculate manufacturing cost anal-
In the analysis of technology maturity of Com- ysis in the simulation program, planned production
pany A case, technology maturity of the eight pro- quantity of the items for 10 years is entered into the
cesses is analyzed through the patent portfolio. First program. The number of planned production quantity
of all, draft of searching formula and keywords for for each item is determined by demand estimation of
finding SMT related patents are prepared based on air conditioner. After that, value of manufacturing
the specifications of the SMT. After that, the search- cost factors for making or buying items is entered
ing formula and keywords are refined by the technol- into the program, when the items make or buy for the
ogy specialist in the field of Company A, and final number of planned production quantity. Then simula-
searching formula is derived. WIPS, the patent in- tion program calculate the one-year total cost of mak-
formation database, is used in this analysis and time ing or buying all SMTpart1, SMTpart2, and SMT-
period for classifying application year of the patents part3 in make and buy cases.
is set into 5-year. Material cost (variable cost), labor cost (semi-
Figure 7 represents the result of the patent port- variable cost), facility investment cost (semi-variable
folio by analyzing based on the number of patent cost), building construction cost (fixed cost), and land
applications and applicants from the Korean, Japa- rent fee (fixed cost) are set as a manufacturing cost
nese, USA, and Europe patents. Patent portfolio of factor when making. SMTpart1, SMTpart2, and
SMT shows that both trends of the number of patent SMTpart3. Purchase cost (variable cost) and shipping
applications and applicants are increasing in the Fig- cost (variable cost) are set as a manufacturing cost

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factor when buying. results of the three perspectives: technological, finan-

The total amount of each Make and Buy cost is cial, and operational. In this SMT example, basically
calculated by the simulation program, and also it taking Make strategy and mixed Make and Buy for
shows the total cost corresponding to production some years is concluded through the analysis of tech-
quantity of Make or Buy in a graph form as shown in nological, financial, and operational perspective. Also
Figure 8. As the capacity of the SMT facility is input a Make or Buy decision making flowchart is pro-
to 500,000 in Make case and facility reinvestment posed as following Figure 9. It can support decision
occurs, there is jumping point of total cost on the makers to decide Make or Buy of manufacturing pro-
500,000 quantity in total cost-production quantity cesses including SMT.
graph. In this case study, Company A wants to build
Make or Buy guideline process in flowchart format in
order to apply the methodology easier. Therefore,
Make or Buy Decision Making Flowchart is present-
ed as following Figure 9.

Figure 8. Total Cost of Make and Buy Corresponding

to Production Quantity

4.3. Step3: Operational perspective in Company A

In the analysis in operational perspective, opti-
mum production quantity is founded through mixing
Make and Buy case in order to increase production
performance. It is applied on the excel-based simula-
tion program connected with the result of analysis in
financial perspective. In using Make mixed with Buy
of SMT items, optimum production quantity is result-
ed from taking better choice by comparing Make and
Buy total cost in total cost-production quantity graph.
In this SMT example, capacity of SMT facility
Figure 9. Make or Buy Decision Making Flowchart
is 500,000, and the number of planned production
quantity in 2016 and 2017 is 600,000. For making
5. Conclusion
600,000 items in 2016 and 2017, it needs to reinvest
additional facility in 2016 because one facility can
In this study, Make or Buy decision making
produce only 500,000 in this case. It means that addi-
methodology is proposed via technological, financial,
tional facility is built only for making 100,000 items.
and operational perspectives. To begin with, in tech-
As you see on the Figure 8, it is more beneficial that
nological perspective, a matrix of technology strategy
only Company A make 500,000 items and buy the
is developed based on the technology importance and
other 100,000 items from the outside in 2016 and
maturity, and it enables decision makers to help mak-
2017. Applying this concept into whole 10 years,
ing decisions in technological perspective. Secondly,
total cost of manufacturing SMT items is reduced.
in financial perspective, through the manufacturing
cost analysis and total cost analysis, Make or Buy
4.4. Step4: Guidelines of decision making in
decisions are supported. Thirdly, in operational per-
Company A
spective, optimum production quantity through mix-
Make or Buy decision making guideline in
ing Make and Buy is reflected on the decision. Final-
Company A is suggested covered previous analysis
ly, Make or Buy decision making guideline consider-

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ing three perspectives is proposed. [6] KIPI (Korea Institute of Patent Information),
In order to confirm the implementation of the Development and case studies of new analysis
methodology in practical, case study of Company A methods using patent Index regarding Technology
Roadmap, MKEKOTEF, 2005.
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