In many cases, it is feasible to produce materials or components or even rou- tine services “in-house”—that is, within the organization. Even though the organization’s competitors may already be producing these materials and components, their selling prices may be higher than production “in-house.” The only time one should consider “making” when it is not cheaper, is for control and quality considerations. The following model is based on the fixed cost per purchased product, as well as the (different) fixed cost per produced product. This model (sometimes called “the Break-Even Model”) is described in Figure 6.1. Cost Break-even Make Make Buy Q Q = Quantity Point FIGURE 6.1
The break-even point model.
In Figure 6.1, it is clear that for quantities below the break-even point, it is cheaper to buy, while for bigger quantities it is better to make. Apart from price, several other factors should be considered when moving toward “make or buy” decisions.
6.2.1 Capacity Considerations
An external source of additional capacity may be needed when demand fluc- tuates, resources are hard to get, or when the organization does not want to invest in producing additional capacity in-house. In the short term, using an external source to acquire additional capacity can help deal with a sudden increase in workload and provide a temporary source of capacity, which may be better than using overtime and extra shifts. In the long run, the organi- zation may choose to increase its capacity by procurement from an exter- nal source because the cost of adding capacity is too high or the resources required are not available. In services, service capacity must be much higher than demand for avoiding excessive wait and long waiting lines.
6.2.2 Know-How Considerations
When technological or commercial know-how is not available and develop- ing such know-how requires considerable investment in the organization or may be uneconomical, impractical, or impossible (e.g., due to patents that belong to other organizations that are the potential suppliers), purchase from an external source is the best way to go.
6.2.3 Core Technology Considerations
Technologies that are at the core of the organization’s products or ser- vice and are the basis of its competitive ability are irreplaceable assets. Companies go to great lengths to develop these even when it is hard to find an economic justification. Mastering such technologies usually has a long- term impact and also has the potential for future advances. Proprietary technologies are typically protected by the organization that tries to keep the knowledge on which these technologies are based under control. Therefore, organizations tend to avoid outsourcing such technologies in an effort to minimize or prevent their competition from stealing or learning to use these technologies.
6.2.4 Economies of Scale Considerations
Typically, establishing production or service capabilities involves an initial investment that makes the product or service cost a decreasing function of volume (known as economy of scale). This situation motivates outsourcing when quantities are too low. For example, when expensive special purpose
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Interface with Suppliers and Subcontractors
facilities, machinery, and equipment are needed and the required volume of production is too low to justify the investment, other alternatives are required. In such cases, purchasing may be the preferred solution. Accumulating experience, ongoing learning, and continual improvement also decrease the unit cost and give advantages to organizations that produce (or serve) large quantities. When the market has other organizations that sell much larger quantities of a certain item, it might be uneconomical to produce this item when the quantities are too small. For example, car producers such as Ford, GM, and Toyota buy their tires from suppliers such as Goodyear or Michelin that produce tires for the whole automotive market.
6.2.5 Quality Considerations
Any product or service requires some input, and its quality depends on the quality of this input. When the quality of the components, materials, or services is high—good overall quality can be achieved in-house. Product or service quality also depends on the quality of means and processes. For example, when the provider has advanced machinery and advanced measur- ing and testing machines, it increases the quality of its products. However, the cost of such machinery is justified only for high enough volume produc- tion (see break-even point Figure 6.1). Thus, using the expertise and the high quality of external suppliers can be a way to improve the competitiveness of a quality-based organization.
6.2.6 Control Considerations
Procurement increases the organization’s dependence on other organiza- tions that are not under its direct control. As a result, the organization is less effective in dealing with uncertainty and risk. A strike by the supplier’s workers, for example, can be destructive to the client organization. Also, the quality of components and materials is not under the organization’s direct control. Monitoring and control of quality is an essential tool in the man- agement of risk and is used as a basis for corrective actions when needed. However, when the items are purchased—that is, not produced in-house— the required corrective actions are beyond the reach of the organization. One remedy is signing a strong and binding contract. However, to ensure compli- ance, supplier monitoring and management is necessary, and is one of the most important tasks when outsourcing is used.
6.2.7 Accessibility Considerations
Supply logistics is an important factor that affects both costs and lead times and must be taken seriously. Distances and transportation means give an advantage to the more accessible supplier. There are times when purchas- ing from an outside source depends totally on accessibility constraints. For
example, when the US military had a large presence in Iraq, many of its acquisitions were made in Iraq or neighboring countries only because of geo- graphical accessibility. Another example is, when raw materials are found only in some specific locations, purchasing from foreign countries may be a necessity. Holding local inventory storage is frequently used in such cases to provide accessibility. Accessibility constraints are not always geographical. For example, the production of hazardous materials may be legal in some countries and illegal in other countries. In many cases, such materials must be purchased from countries where authorized suppliers can operate.
Decisions to buy or make are made at the strategic level (the level of policy making), as well as at the tactical and operational levels. At the strategic level, decision tends to focus on which parts of the product or process have to be made in-house. At the lower levels, ad hoc decisions such as to maximize the use of the organization’s production capacity and some subcontractors when demand is high may be needed. In both cases, if the organization decides to purchase from an external source, the contract and supplier management are important issues to be considered.