PEMP-EMM2506

Make or Buy strategy

Session Speaker
Prof.P.S.Satish
M.S Ramaiah School of Advanced Studies - Bangalore 1
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Session Objectives

To assimilate meaning and application of Make or Buy

strategy

To assimilate the appropriate decision making process in

purchase management

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Session Outline

Make or Buy Choice

Make or Buy status Quo
Make or Buy Factors to be considered
Session Summary

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MAKE OR BUY Choice

One of the key strategic issue in manufacturing is

the decision regarding what to make and what to
buy

Companies rarely make their own products/

services from start to end

Mostly these decisions have been taken on an ad-

hoc manner and lack adequate strategic
consideration

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Make or Buy Decision

L&T Komatsu decides to have welding

Robot In house. Why ?

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MAKE OR BUY Choice

Traditional reasons for choosing between make or buy

Inability to make in-house (technical capability/ high

investment / low utilization)

Retaining core technology e.g. Process valves and

automobiles (retaining assembly stage onwards in order
to ensure design security, final product quality & its
testing, link with the customer etc.)

Standard technology available freely in market is

normally off loaded

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MAKE OR BUY Choice

BREAK EVEN ANALYSIS

Cost factors- when sources TOTAL COST -BUY

outside the company work
out cheaper; especially true
of highly labour oriented COST

services TOTAL COST -

MAKE
MAKE-FIXED
COST

MAKE-VARIABLE
COST

BREAK VOLUME
-EVEN

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Make or Buy
Fixed cost = FC
Variable cost = C
Quantity = Q
Total cost = FC + Q*C
Decision to make or Buy is based on break
even point
If total cost is more after breakeven quantity,
make .otherwise buy
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MAKE OR BUY Choice

Transaction cost of Buy has to be factored in

This is especially true in the Indian context where

excise duty is locked up and cost of paper work is
quite laborious.

In industries involving high cost materials,

material balances have to be accurately tracked
e.g. Metal processing & jewellery

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MAKE OR BUY Choice

By buying ,benefit of specialist and better

technology can be availed. Options to avail
technology up-gradation in market is high

Cost is more accurately measurable when parts are

outsourced

It is always easier to tell than do!. External person

can be made accountable better

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Make or Buy Choice

Environmental factors is also a factor to look
into for Make or Buy. Suppose the company
is not a position to manage effluent
treatments or no clearance from Government,
they may opt for Buy from approved
agencies
Choice has to be made considering both
aspects of short term benefits and long term
sustainability
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MAKE OR BUY - Status Quo

Some of the reasons for status quo in making/

buying decisions

Normally, response to a make/buy decision is

automatic, based on technology and then cost
considerations

Historical reasons that have not been reviewed

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MAKE OR BUY - Status Quo

Inertia & non-availability of executive resources

to review the decisions taken earlier

Avoiding of short term problems consequent to the

changes

Dominance of cost & technology factors

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MAKE OR BUY - Status Quo

Shedding of jobs is quite difficult. Hence Make
is easy way out.

Many manufacturing units take a short term

approach and off load the difficult part of the job.

However, in the long term this involves loss of

skills ; Know-how gets transferred to the supplier
e.g. Ship building in Germany japan

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MAKE OR BUY - Status Quo

Companies also off-load jobs in order to escape

associated government regulations e.g. Such as
environmental impact, safety/ health issues etc

Many companies off load service functions in

order to avoid dealing directly with the authorities

There are cases where offloading is done to

manage quality. This is not right but some section
of company work on this strategy.
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MAKE OR BUY - Factors to be considered

Make or buy decisions need to be made within the

strategic context of the business do we create new
strategic capabilities or buy ? What is the lead
time? What is the effect on current vendors?

Effect of the decision on companys order winners/

qualifiers (manufacturing outputs) (cost, delivery,
reliability, quality etc.), has to be carefully
evaluated

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MAKE OR BUY - Factors to be considered

Similarly, assurance of supplies through make

decision cannot be overlooked, if it is an order
winning factor

Issues concerning process and product technology

needs to be factored in

Current capacity utilization and implications of

adding capacity

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MAKE OR BUY - Factors to be considered

where a company does not possess product/ process

technology, it buys it in the form of components. (e.g.
purchase of abrasive grains in manufacturing grinding
wheels)

this is especially true for companies which want to

apply newer technologies

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MAKE OR BUY - Factors to be considered

internal span of processes get narrowed or
widened, based on make or buy decisions

whether to integrate backward and gain the

value addition or live with the current value
addition by outsourcing needs to be
considered.

threat of component supplier integrating

forward and taking away the business of
the company has to be considered
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MAKE OR BUY - Factors to be considered

Where a wide span of activities creates entry barrier

advantage to a company, it is a strategic advantage to
make rather than buy

Many multinational companies having manufacturing

units in multi locations have changed the strategy of
making/ buying to take advantage of reduced local
tariffs and economy of scale of operations of the parent
organization

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MAKE OR BUY - Factors to be considered

When the volume of a product gradually

diminishes and reaches a low level, it can be
outsourced. This reduces the span of operations
within the company. Typical examples include
automobile and machinery spares. In the final
stages, company only provides drawing to the
buyer and indicates likely sources

Supply chain & inventory issues are related to

make/ buy decision

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Make or Buy-Cost factors

Make : BUY :
1. Operating expenses : 1. Purchase cost
- Direct Labour 2. Inbound Freight
- Direct material 3. Space
- Inbound freight 4. Administrative cost to manage supplies
2. Facilities 5. Investment
3. Depreciation 6. Inventories cost
4. Overhead 7. Working capital cost
5. Direct management cost
6. Cost of Inventories
7. Working capital cost Decision based on
savings after taxes
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Make or Buy : Decision process

1. Strategic Alignment
2. Core Competence Alignment
3. Technological maturity
4. Total cost of ownership
5. Implementation

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Make or Buy : Decision of Make

Advantages Disadvantages

High degree of control over inputs - High Volume required

Visibility of overall process - High investment needed
Economies of scale - Dedicated equipment has limited
Can respond to customer better use
- Problems with supply chain

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Make or Buy : Decision to Buy

Advantages
Greater flexibility
Lower investment risk
Improved cash flow
Lower potential labor costs
Competition outside can
decrease cost
Disadvantages
- Possibility of choosing wrong supplier
- Loss of control over process
- Long lead time
- dependency may increase over years

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Make or Buy : Toyota Way

When Toyota developed prius hybrid car,a
core part of computer system Insulated Gate
Bipolar Transistor had to be developed. Toyota
was not good at semiconductors. But they
decided to develop and put up a new plant for
Manufacture. Why?.
Toyota wanted Self-reliance as this
Technology would lead to future & will give
them competitive advantage
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Make or Buy Decision

Any Investments in Industry should yield in

excess of cost of capital
Capital Investments are not made if it does not
return at least cost of capital
One of the area to look at while investing is
Make or Buy

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Make or Buy Decision

One of the method used in decision process

in calculation of NPV ( Net present Value)
Decision is based on cash flow return over
years and it will be converted to todays
value considering inflation

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NPV
It is a standard method for financial appraisal of long term
projects

It is the difference between the market value of a project and

its cost

It evaluates present value of net cash flows

Cash flow is discounted back to its present value(PV) for each

year

Then it is summed up. After this initial investment is subtracted

to get NPV

NPV does not consider market risk. This risk to

be added in calculation under discount

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NPV Calculation

Higher NPV is
favoured for the
decision
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Span of Process

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Make or Buy

Debate about make or buy decision for a

Modular or Integral product ?
Which one is more risky to buy ?

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Session Summary

Factors to be considered for Make or Buy decision has

been explained

Span of process with respect to technology has been

discussed

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