“CLASSIFYTHE FACTORS THAT WOULD HAVE TO BE TAKEN INTO ACCOUNT IN A

‘MAKE OR BUY’ POLICY DECISION, PROCESS DERIVE THE ‘MAKE OR BUY’

POLICY DECISION FOR A NEW PRODUCT INTRODUCTION.”

Under Guidance
Raja Khalid
Hafeez Presented
By
 Maheen Sohail
 Nazir Ali
 Waleed Ahmad Qureshi
 Shehriyar Ansari
 FOREWORD
“Glory to Thee: the knowledge we have none, save what Thou host thought us.”

Business environment is becoming more and more complex and uncertain with
the passage of time. To understand and deal with this riddle phenomena one
needs a lot of capabilities and practical exposure. So, business education has
become an evolving science that helps to solve business problems. Academic
education provides erudite knowledge about business decisions & policies and
practical exposure enables us to know what is happening in business world. To
become professional in any field only abstract knowledge does not provide a
concrete base. This is a unique approach of particularly Bahria University to
provide the opportunity to their students to observe the daily business practices
and problems.
The project is one of these leading features of this discipline that fills the
deficiency and helps us in scanning & analyzing various organizational and
social problems and decisions such as Launching of a new product in this
competitive market situation, how to market our business and products,
innovations and expansion of business. We have learnt a lot from this project of
applied research.
 ACKNOWLEDGEMENTS

By the grace of Allah Almighty and the utmost efforts of our group members, we
are able to accomplish our project well in time. At this moment we must pay
special thanks to our devoted teacher Sir, Raja Khalid Hafeez for his
cooperation and guidance that made us, accomplish our project. Also, it is a
matter of great pleasure for us to put our efforts in front of well-esteemed
personalities. We are also grateful to other group members who showed a keen
interest and cooperated whole-heartedly throughout the entire course of our
activities.
Table of Contents
ABSTRACT......................................................................................................5
HISTORY.........................................................................................................5
INTRODUCTION................................................................................................6
WHAT IS A MAKE-OR-BUY DECISION?.......................................................................6
...................................................................................................................................................................7
MAKE..........................................................................................................7
BUY...........................................................................................................7
FACTORS CONSIDERED FOR MANUFACTURING (MAKE)...................................................8
FACTORS CONSIDERED FOR BUYING........................................................................8
CRITERIA FOR MAKE OR BUY DECISION.....................................................................8
SIMPLE COST ANALYSIS.......................................................................................9
TO MAKE....................................................................................................10
TO BUY......................................................................................................10
ABSTRACT:
The make-or-buy decision is one of the most difficult problems in the business
strategy. Companies have finite resources and they can’t always afford to have all
manufacturing technologies in‐house. This has resulted in an increasing awareness of the
importance of make‐ or‐buy decisions. It is basically a choice between manufacturing in-
house and outsourcing a part in the product to ensure a performance of any manufacturing
firm. There are several factors involved in making such decision but most manufacturing
companies use cost as a main factor to decide whether to make-or buy a part in the
product. Decisions usually arise when a firm that has developed a product or part, or
significantly modifying, is having trouble with current suppliers, or has diminishing
capacity or changing demand.

The decision to make or buy extends beyond manufacturing, human resources, information
technology, and other fundamental business activities. Operational manager have a key
role to play in helping business firms make these decisions given the skills and objective
perspective their teams bring to the effort. This report explores the dynamics of make-
or-buy decisions and presents a factors to help companies make the right decisions. The
analysis is built on three key pillars; simple cost, economic cost and break-even point.

HISTORY
The conceptual basis for a “Make-OR- Buy” decision is (Williamson’s 1975) theory of cost
analysis. Transaction cost analysis combines economic and management Theory to
determine the best possible relationship a firm can have with a marketplace. During the
1980’s and 1990’s, many firms found vertical integration to be inflexible in the rapidly
changing business environment. Looking at the example of GM, with a high level of vertical
integration, suffered from high costs due to its union workers, AS earning twice as much
as non-unionized workers working with suppliers (Walters, 1996).

However many companies and firms also face problems pursuing such strategies. Some of
the important problems companies face in a “Make-or- Buy” decision in NPD.Because there
isn’t a formal way to evaluate such decisions. Many companies make decisions based
on overhead costs, rather than business sense The “Make or Buy” decision is highly
complex and one of the most difficult tasks faced by firms. It requires excellent analysis
to assess the underlying tradeoffs as well as a balance to the short as well as long term
goals of the organizations.
INTRODUCTION:
Make-or-buy decision is a concept in the management practice. Normally, companies do
not need to buy the inputs from other companies when the inputs can be manufactured in
less cost. On the contrary, it is also the same. The make-or-buy decision, also known
as “sourcing”, “outsourcing”,” is among the most pervasive issues confronting now a
days. To satisfy customer demand, the company has three alternative policies, namely in-
house production (make), outsourcing (buy), or mixed between make and buy. Outsourcing
is not a simple activity since it deals with critical decision making to determine
appropriate suppliers from whom the components should be purchased. As uncertainty in
term of supply, process, and demand make the outsourcing even more complex.

WHAT IS A MAKE-OR-BUY DECISION?

It refers to an act of using cost-benefit tool to make a strategic choice between
manufacturing a product (in-house) or purchasing from an external supplier
(outsource). The make-or-buy decision compares the costs and benefits that results by
producing a good or service internally against the costs and benefits that result from
outsourcing. For an accurate comparison of costs and benefits, one needs to analyze and
evaluate the benefits of purchasing expertise against the benefits of producing the same
expertise within the company.

Similarly, organizations 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 etc. Organizations must also include inventory holding costs,
which comprise warehousing and handling costs, as well as risk and ordering costs.
MAKE:
It requires suitable production equipment, appropriate personnel,
material, sufficient space, supervision, design standards and involves
overheads, maintenance, taxes, insurances, management attention and
other indirect and hidden costs. It provides work for idle equipment
and scrap material, shorten delivery period, and quality of final
product. It ensures continuity of supply, may cost less than purchase
and keep design and research information secret.

BUY:
Permits lower investment in facilities, small labor force, less handling, lower plant cost
for building, less overhead or taxes, insurance and supervision and less
problems of man-management relations. Buy permits specialization,
allows manufacture by most efficient equipment, lowers
inventories, change of design without loss of investment in
equipment or inventory, obtaining best price of product, and
supplying more varied experience and encourages growth of
ancillaries.
Whether to make or buy is sometimes referred as a purchasing
function, though the decision whether to make components in one’s
own factory or to buy them from market is a top management
policy matter.

Theoretically, a company has choice of three alternatives before starting for a new product:

 Purchase the product complete from a contracted manufacturer

 Purchase some components and materials, and manufacture and assemble the
bal•ance in its own plants
 Manufacture the product completely, starting with the extraction of basic raw mate•rials.

In practice, almost no company considers the third alternative. Some companies choose
the first alternative and obtain a new product completely from another company. These
companies usually have no manufacturing units, but sell the product under their trade
marks.
But in general, most of the companies make certain components of a product and buy
others. The companies may buy a component from outside in semi-finished or complete
state or buy the raw material only.

FACTORS CONSIDERED FOR MANUFACTURING (MAKE):

 Are patents or copy rights involved?
 If so, what are the royalties?
 Have the best prices been obtained?
 Are the quantities optimized?
 Is the previously contracted firm already making something similar which could be
added to the new item, thus reducing production cost?
 Techniques of production may be special.
 Is raw material readily available?
 If free material to be provided?
 Will any tax be involved?

FACTORS CONSIDERED FOR BUYING:

 What quantities are involved?
 Will drawings need modification?
 Whether tools, gauges are loaned?
 Will demand be temporary or permanent?
 Will demand fluctuate?
 Are special manufacturing techniques involved?
 Is there any question of secrecy?
 Is there a likely market elsewhere?
 Are frequent design changes likely?
 Arrangement for inspection, sampling etc.
 Retention of own production personnel.
 What notice of termination is required?

CRITERIA FOR MAKE OR BUY DECISION:

Companies prefer own manufacturing and buying only raw material or semi-finished
parts. Such decision is made in the following cases:
 Finished product can be made cheaply by the firm than that by the outside suppliers.
  Finished product only is manufactured by limited number of outside firms,
which are unable to meet the demand.
 The part has an importance for the firm, and requires extremely close quality control.
 The part can readily be manufactured with the firm’s existing facilities and the
part is similar to other items in which the company has manufacturing
experience.
 Requires high investment on facilities, which are not available at supplier’s plant.
 Has a demand that is both stable and relatively large.

Companies will usually buy a finished part from an outside supplier when:

 They do not have facilities to make it and there are other profitable
opportunities for investing company capital
 Existing facilities can be used more economically to make other parts
 The skill of personnel employed by company is not readily available to manufacture
the part.
 Patent or other legal barriers prevent the company for making the part.
 Demand for the part is either temporary or seasonal.

ANALYSIS FOR MAKE OR BUY DECISION:

There are three type of analysis:

 Simple cost analysis

 Economic analysis
 Break-even point

SIMPLE COST ANALYSIS:

A make or buy cost analysis involves a determination and comparison of the cost to
make the part and the cost to buy it. The final make or buy decision must be based on
a careful weighing of the cost considerations and various quantitative considerations.

The most difficult make-buy factors to assess are those that will significantly be affected
by change in economic conditions, technological advancement, growth of the firm, or
changes in the labor manage•ment relations in the future. Studies show that more
mistakes are made in making what could be more profitable to bought than in buying what
could more profitable to be made.

Following major elements should be involved in a ‘make or buy’ cost estimate:

TO MAKE:
 Delivered purchased material costs Direct labor costs
 Any follow-on costs Incremental inventory carrying costs
 Incremental factory overhead costs
 Incremental purchasing costs
 Incremental managerial costs
 Incremental costs of capital.

TO BUY:
 Purchase price of the part
 Transportation costs
 Receiving and inspection costs
 Incremental purchasing costs
 Any follow-on cost related to quality or service.

To get a clear picture, must carefully analyze these costs considering the effects of time
and capacity utilization. Cost figures must include all relevant costs, direct and indirect, and
they must reflect the effect of anticipated cost changes. Since it is difficult to predict
future cost levels, estimated average cost figures for the total time period in question
are generally used.
Take an example:
From the above table we conclude that if an organization want to make this item rather
than but it from external source, needs to reduce the cost of the part from 0.60 to
0.42. If in case a firm has a capacity that it can make the product with the maximum
overhead of 0.12 per unit. On the other hand, wants to invest additional to the
facilities to make that item along with normal overhead then unit cost will be 0.54
then it is worthwhile to make the part.
On the basis of above cost analysis, it is quite clear to the operational manager that the
decision must be in favor of buying the part.

Conclusion:

From the above result we should go for buy and reason are; Due to large volume of Production,
we have lack of empty space to make and store. Cost of the production is higher than the cost of
buying and we gain more profit. Another major advantage of buying instead of manufacturing is
to use that production space to generate profit (i.e., By giving it on rent). For the production we
need manpower in form of labor and most of the time we need skill labor which is not available
in Pakistan Market, or we need to train labor first which result in increase in cost of product.
Sometimes, there’s unavailability of competent supplier or vendor, which also effect the cost and
hit the profits badly and fixed cost also gets higher.
In above case company need to invest in an additional facility to reduce overhead cost and to
make that item along with normal overhead. On other hands, company can buy the same product
in less price than its manufacturing cost.