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DESIGNING AN APPLIED MODEL IN MAKE OR BUY DECISIONS CONSIDERING

THE HIDDEN COSTS AND SUPPLY DISRUPTION RISK (A CASE STUDY:
AGRICULTURAL SPRAYER MANUFACTURING COMPANY)

Article · September 2014

DOI: 10.7813/2075-4124.2014/6-5/A.12

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INTERNATIONAL JOURNAL of ACADEMIC RESEARCH Vol. 6. No. 5. September, 2014
Y. Yarmohammadi, K. Khanbabaie, A. Yasini, R. Maleki, Kh. Mafi. Designing an applied model in make or buy decisions
considering the hidden costs and supply disruption risk (a case study: agricultural sprayer manufacturing company).
International Journal of Academic Research Part A; 2014; 6(5), 81-91. DOI: 10.7813/2075-4124.2014/6-5/A.12

Library of Congress Classification: S1-(972)

DESIGNING AN APPLIED MODEL IN MAKE OR BUY

DECISIONS CONSIDERING THE HIDDEN COSTS
AND SUPPLY DISRUPTION RISK
(A CASE STUDY: AGRICULTURAL SPRAYER
MANUFACTURING COMPANY)
1 2 3 4 5*
Yones Yarmohammadi *, Kobra Khanbabaie , Ali Yasini , Razieh Maleki , Khaled Mafi
1 2 3
Allame Tabatabai University, Tehran (IRAN), Payame Noor University (IRAN), Ilam University, Ilam (IRAN),
4
Azad University of Science and Research Kermanshah Branch, Kermanshah (IRAN)
5
Sultan Zainal Abidin University, Kuala Terengganu, Terengganu (MALAYSIA)
*Corresponding author: Yarmohamadi_65@yahoo.com

DOI: 10.7813/2075-4124.2014/6-5/A.12

Received: 06 Feb, 2014

Accepted: 18 Aug, 2014

ABSTRACT

Make or buy decision, is one of the production strategies of the industries. Despite its effect on the
dynamism of economic institutions, the problem of make or buy decision is usually viewed as a short-term matter,
which is based on costs and operational considerations. The environment dynamism and unreliability of suppliers’
performances have caused some changes and re-considerations in the present algorithm of companies’ make or
buy decisions. The aim of this research is to answer the following question: How can an algorithm be found
through which the decisions regarding the component production by the manufactures or ordered by the suppliers
can be made, considering the effective factors on make or buy decision process? In this paper, considering the
necessity of adopting a new attitude toward the problem of make or buy in sprayer manufacturing companies, this
algorithm was reconsidered and represented. Crystal-Ball software and simulation were employed in make cost
computations due to the uncertainty of some parameters. Having applied the algorithm as a case study, some
were made regarding changing make or buy strategies in the mentioned companies. Based on the gained results,
their implementations were suggested such that the algorithm was redesigned in terms of other effective factors
on make or buy decisions. The consideration of investment costs and disruption risk in the suggested algorithm
provided the novelty aspect of this research.

Key words: make or buy disruption risk, hidden costs, investment, agricultural sprayer

1. INTRODUCTION

The idea of outsourcing of a firm’s chain value is not a new subject. Different firms and industries of the
world have been facing this matter for years. In the construction sector, most industries outsource their
automation, computer hardware, and even the production of some devices to outer specialists. For instance, Ford
and General Motors have outsourced the production of more than 50% of the devices of their final products. The
main motive of outsourcing is to save money and improve the quality due to economy of scale and the specialty of
the salespeople/providers.
The consideration of make or buy process is of a great importance among the workmen and researchers
(1). Make or buy decisions are also known as resource-finding, outsourcing, or secondary contracts (2).
In fact, make or buy decision is one of the strategic decisions in every organization which have long term
and long-lasting results and consequences for them; such a decision must not be considered with a short-term,
economical, and quick viewpoint (3). Make or buy decisions can affect the firm’s strategy, cost structure,
competitiveness, flexibility, service delivery level, and competitive advantage (3, 4, 5).
Make or buy decisions are of the most critical and challenging decisions in joint product manufacturing
industries. These companies produce products including hundreds of separate parts and components. Each
component may be produced whether in the company or by the outer providers. In decision making to choose the
supply source, some other factors are effective per each part, in addition to factors such as the material kinds,
costs, and other operational variables. There are issues such as core competencies, the expectation time, the
supplier quality, delivery performance, risk, etc. In case of the presence of all these factors in a decision making

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process, we will be faced a completely complicated problem related to profitability. Any mistake can result in the
weak performance of the company (6).
Basically, make or buy decisions are made in two general methods of knowledge-based and case based
reasoning. The knowledge-based systems are considered as computer programs which solve the problems by
imitating the problem solving behavior of a specialist. The production of knowledge-based system deals with the
acquisition of knowledge and logic/the problem solving methodology on the real world’s issues related to a
particular realm of knowledge. Knowledge-based system has been used in order to evaluate and select the
potential suppliers and consider the importance of buy item in the company sourcing (7).
While CBR(case based reasoning) is a problem solving approach which relies on the past and uses similar
cases in finding the problem solution, modifying the available solutions and justifying the abnormal situations.
CBR is a rich knowledge-based method in acquiring the past experiences, increasing the number of the available
solutions and totally improving the learning capabilities. In CBR, a new problem or situation is compared with a
reference or library of stocked cases (3).
During the past years, the company in question has provided a major part of its required parts and
components in assembling the final products using outsourcing and lateral contracts. Regarding its long
background in making different kinds of agricultural sprayers and using outer suppliers in producing components
of the final products, this company(is now to decide about using systematic algorithms in its make or buy
decisions. The problem of make or buy is considered with a strategic approach in this paper.
Make or buy decisions of this company have been made as short-term and on the basis of cost
considerations. The entrance of new rivals to the market and the fluctuations of the economic environment in the
past years, and especially the last year’s, have faced most of component supply contracts with the problem of
delay and/or cost balancing and therefore, the company has been seriously challenged regarding the supply of
customers’ demands. Therefore, the problem of make or buy or review has become important, followed by the
definition of the main problem related to make or production strategies. As a result, the necessity of re-defining
many of the issues related to the problem of make or buy is felt due to the dynamism and the variable conditions
of the environment. The investigation of the re-production of some outsourced components and investment in the
provision of equipment and machinery aiming at capacity production and assuring its justification are of much
importance. Consequently, regarding the presence of new rivals, the review of the method of competency
consideration and the companies’ equipment is necessary.
In the second part, the research background has been considered and presented. In the third section, the
algorithm or the applied model is explained and in the fourth section, the model is presented and its results are
analyzed using real data. And finally, the conclusion and suggestions are presented.

2. REVIEW OF LITERATURE

Traditional approaches in make or buy decisions are mainly based on financial economics’ index and seek
to answer whether other companies can produce that particular device or process with less price in comparison
with domestic production or not. Coase stated for the first time that in calculating the costs, demands costs should
be also considered in addition to market costs; this was the same theory of transaction costs presented by
williamson and described the complexities of transactions costs. What has been considered in this article is in fact
the effect of the hidden costs on make or buy decisions which have attracted less attention so far(8, 9).
Many researchers have worked in the field of make or buy decisions; below some of them are mentioned:
Peng et al. considered make or buy decisions in the field of export (10). Humphreys et al. presented a
system to evaluate make or buy decisions. They stated that their aim was to show the fact how knowledge-
oriented systems’ technology can help the decision makers (11). Moschuris discussed the organizational
participants in make or buy processes. He stated that few studies have been performed on organizational
participants in make or buy processes. Relying on the available theories, he considered the participation level of
organizational key participants in make or buy decisions and the effects of field variables (1). Cotellessa et al.
presented an optimization framework for make or buy decisions in software mystery. They presented a linear
optimization model of cost/ quality to deal with make or buy decisions. In their model, they attempted to minimize
the costs considering a satisfying quality level (12).
Outsourcing/ insourcing decisions play a vital role in organization performances. The importance of such
an approach has been doubled by the consideration of the recent management trends which focus on core
competencies and other outsourcing activities in order to reach to a competitive situation and its maintenance.
The main question that organizations are facing is that which components or product parts they must produce and
which ones should be bought from the suppliers. Answering these questions is known as the make or Buy
decisions.
At least, 3 features have been introduced to identify the core competencies in a company; firstly, the core
competencies make possible the potential reaching to the extensive markets; secondly, a considerable portion of
understood customer benefit of the final product must be obtained, and thirdly, its imitation and copying must be
difficult for other rivals (13)
Being inspired by the article of Prahalad and Hamel, Quinn and Hilmer considered the competence -
orientation as the main strategic concept and the determining factor in outsourcing decisions and defined the
following features as the effective factors on competence-orientation. The core competencies are a set of
knowledge and skills, rather than products or duties; they are flexible and long term operational stimuli having the
ability of adaption or gradual completion; they are limited in number, they are fields in which companies can
become skilled; they are important in customers’ views and have been mixed with organizational systems (14).

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A model has been presented for outsourcing decision making using the combination of transaction costs
economics and the approach to competence orientation.
The findings of this article prove that there is no economic benefit in outsourcing activities whose
transaction costs are not decreased this way Similarly, the activity which is strategically important and is vital to
the survival of the company must not be outsourced. They judge the "strategic importance" through finding the
competitive portion of that activity An activity is strategically important when it is competence-oriented and
provides competitive benefit, as well. The activities which do not have a portion in competitive benefit are all
candidates of outsourcing (15).
Sislioan and Satir have integrated 5 factors of competitive benefit, demand flexibility, process capability,
process maturity and strategic risk in the form of a 2-phase framework of strategic outsourcing. The first step
related to sourcing decision includes the first 2 factors and the second step that includes the remaining 3 factors
is the required activities to perform decision making (16).
Another sourcing strategic framework has been extended which investigate the different aspects of
process technologies involved in sourcing decisions such as the role of the process technology in providing
competitive benefit, the maturity of the process technologies being considered and the situation of the rivals’
process technologies. In this framework, a table of 3-dimensional decision has been employed in sourcing
decisions to reach to a decision on the basis of "make”, "final make", "buy", and "final buy". For instance, when
the role of the process technology is considered "high" and the process is considered "mature" and also the
organization process technology is rated "better" in comparison with rivals’, the sourcing decisions, then, must
consider the option of "final buy" as desirable (17).
Quinn and Hilmer developed a sourcing framework on the basis of a decision matrix. This framework
consists of 3 main components including the derived competitive benefits of the activity, the strategic vulnerability
resulted from out sourcing and the transaction costs due to outsourcing. The output of the decision matrix
determines the organization control level which is required for performing a particular activity (14).
Just like Welch and Nayak, Probert has a technological attitude towards make or buy decisions. In their
views, the growing importance of make or buy decisions is one of the key issues of sourcing strategy in
manufacturing industries. The performed investigations confirm the similarity of senior managers’ views in
manufacturing industries on the importance of these decisions in their business strategies. He confirmed that
there are four stages to do this which are: 1) the firm’s internal evaluation; 2) inner/outer analysis; 3) the
production and evaluation of different states; and 4) the optimum strategy’s selection. In addition, Probert
presented the results of employing the above mentioned buy or make methodology in engineering-manufacturing
businesses. He has reported the beneficial and positive effects of employing this methodology with cases such as
the 20-40% improvement in asset return ratio and the 30-60% decrease in stock and the decrease of expectation
time (18).
The 4 phases outsourcing model has also been extended. The first phase includes the core or non-core
activities of the organization. The senior managers should participate in this phase with the intermediate team. In
the second phase, the evaluation of these activities is done against the best foreign suppliers. The third phase
measures all real and potential costs of the sourcing activity. In the final phases, the relation is analyzed
according to the supplier of the market (3).
An activity-based costing model on joint products decision has been developed which combines the
capacity expansion and outsourcing features using a mathematical programming approach. The suggested model
in this article can simultaneously evaluate the comparative benefits of the expansion of different kinds of capacity
and outsourcing. Using this model, companies producing joint products can optimally decide about the process of
capacity expansion and outsourcing (19).
A strategic framework has been presented for make or buy decision process with a case study in an
automobile manufacturing company in India, in which partial outsourcing has been considered as a strategic
option versus complete make or buy decisions to avoid the suppliers’ opportunistic behaviors and has also re-
considered the present make or buy decision and has clearly identified different points of risk evaluation which are
necessary in make or buy decision process 20).
An outsourcing framework has been suggested on the basis of transaction cost theory and the theory of
the basic source and dynamic capability. This framework consists of 3 parts: the analysis of competitive benefit
portion, the analysis of the relative situation of the capability, and the analysis of opportunistic behaviors regarding
outsourcing decision. The suggested framework attempted to relate the complementary and opposite features of
each 2 theories to a definite decision algorithm in outsourcing decision (21).
The matter of strategic sourcing has also been presented from capital budging viewpoint and authors have
realized that the outsourcing decision leads to the freedom of financial sources to be allocated to other activities
and opportunities and vice versa. Therefore, the mentioned mechanism will result in the comprehensive
consideration of the problem of make or buy combined with capital budging (19).
A multiple criteria decision methodology has been employed in deciding about the combination of sourcing
strategy in information technology projects. This article suggests the multiple criteria decision methodology to
reach to an effective solution, combining 3 methods of Dimatel, network analysis process and 0 and 1 goal
programming. The final results of the research show that not only an organization can simultaneously benefit from
the internal and external sources in prioritizing the duty priorities inside the sourcing decision portfolio, but also
can optimize the operational strategy having consulted with specialists, despite the limited sources (22).
A study has been performed on multiple sourcing under supplier failure risk and quantity discount with
genetic algorithm approach. This article investigates the matter of order allocation of a manufacturer/buyer among
multiple suppliers under supply disruption risk. The non-linear programming model of compound integer has been

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developed to allocate orders considering different capacities, the failure probability, and quantity discounts for
each supplier. The results of this article show that the supplier costs have more effect on the allocation of orders
than the probability of the supplier failure (23).
There is a formal definition of supply disruption risk which refers to "the potential occurrences of an event
in supply which can exert considerable harmful effects on buy decision of a company" (24).
The definition of supply chain disruption in this paper is as follows: un-programmed and unexpected events
which challenge the normal flow of goods and the material inside the supply chain (25).
A multi-Item simulation model and hierarchical supply chain has been modeled by the introduction of
supply network disruption with scenarios with different probabilities and severity. In this model, Monte-Carlo
simulation has been used to determine the distribution of volume loss probability in comparison with the scenario
without supply disruption through the network (26).
Supply disruption can have huge impacts on the firms. They can be in the form of costs, operational and
service effects as supply chain disruption consequences. There are a lot of general examples of supply disruption
which include transportation delays, weak communications, disruptions in IT performance, industrial accidents,
quality issues, operational issues, governmental regulations, and even suppliers’ opportunistic behaviors (27).
Table 1 shows some of the models mentioned in the literature review section.
Since the make or buy models have been expanded, investment and the supply disruption risk in the
equipment have rarely been focused. The non-consideration of investment and supply disruption risk blurs the
reality aspects of the problem condition. In this research, it has been attempted that the costs of supply disruption
which is refundable from the firm contracts and the investment costs in machineries which have been calculated
with the present net value by Crystal-Ball simulation software be considered. Therefore, it is clear that considering
supply risk and investment that are exist in machineries, will have logical and real results.
As it is inferred from the above mentioned articles, relying on the strategic aspect in designing sourcing
decision mechanisms has become important. Considering core competencies, the strategic importance of the
activity (component) and its related risks, the authors have attempted to present appropriate algorithms for
decision making regarding the start of producing by the manufacturer or outsourcing the activity to foreign
suppliers. Some have also focused on operational aspects (such as preventing suppliers’ opportunistic behaviors
and decreasing risk through partial outsourcing).

Table 1. The summary of make or buy approaches

Author Key points Model defects

-It is a completely conceptual method
This model presents a framework based on
-There are not methods for every phase for consideration
the following criteria:
and decision making
3 -Core competencies
- The presented model is not prescribed for all the issues related to
-Capabilities (internal compared to foreign)
decision making in this field, and has only be considered for strategic
-Costs ( internal compared to external)
cases, focusing on a collaborative relation with the selected supplier
Presenting a model to analyze make or buy decisions aiming at
the four following main goals:
The lack of decision making precision in evaluating options, compared to
-Maximizing competitive strategic performance
2 qualitative criteria leads to uncertainty in evaluating operational and
-Maximizing management performance.
financial performance of the options
-Minimizing sourcing risk
-Maximizing financial performance
-A linear programming model
-In this model, decisions are made only based on costs,
-The problem is considered in a way that the demand outgrow
especially tangible costs.
28 the company’s production capacity
-The option of investment has remained hidden for production
-Model aim: the maximization of the obtained profit from
in the country, regarding the problem conditions.
production and outsourcing.
A strategic framework for buy or make decision based on a
Decision making is performed, on the basis of criteria such as
case study in an automobile manufacturing company in India,
20 strategic importance, competitive benefit and out sourcing
which simultaneously considers 3 matters of costs,
risk in a qualitative manner.
competency and risk.
The development of an activity-based costing model on joint The model is completely conceptual. It has very detailed
17 products decision which suggests the capacity expansion and information on the processes, equipment and machinery,
outsourcing using an integer joint programming approach. the hours of machinery functioning, etc.
The presentation of the suggested algorithm to formulate make -The simplicity of the premises such as:
or buy using genetic algorithm, aiming at determining the -The specificity and the certainty of demand and supply fee
29
optimum amount of make or buy for every product and - More production ratio, than demand ratio
maximizing the total costs. -Non-permission of shortage in the suggested model.

Regarding the research problem, the review and re-consideration of some of the above mentioned models
and algorithms are required, regarding the costs of unfaithfulness to one’s promise or suppliers’ opportunistic
behaviors, the investment approach in capacity or make equipment development. In this article, it is attempted to
consider this matter in a systematic framework and present a suitable methodology in order to re-consider the
make or buy problem.

3. METHOD

3.1. The Suggested Algorithm

The present study considers make or buy decision in an agricultural manufacturing company in Iran. This
company manufactures agricultural sprayers with 100-200 liter containers. The product tree of every sprayer type
consists of at least 60 and at most 130 components. The main components at the main principle of every product
tree are mainly plastic, iron metal and non-iron metal. It should be noted that some other lateral and spare
materials are also used in the assembling phases.

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INTERNATIONAL JOURNAL of ACADEMIC RESEARCH Vol. 6. No. 5. September, 2014
The total number of the components which are used in final products outnumbers 400 and about 80% of
these components are provided through outsourcing. The outsourcing process is also performed in 3 forms. The
first type is those components which are not produced in internal markets and are imported from foreign
countries; these components are provided through the internal mediators who have long term contracts with
external suppliers. The main problem of this type of components is their too much dependability on currency ratio
that challenges the firm in terms of long term contracts for final goods’ production. The other type is the
components which have high strategic importance and are produced inside the country. The outsourcing process
for this type of components is to have long-term contracts with the supplier through which the supplier has to
deliver the components in the expected stocks during particular times. The last type of outsourcing is mainly used
in case of goods, in which no complicated technology is used and is abundant in the market; this kind of
components are usually bought from a few trusted suppliers whose trust has already been tested. The most
important goal of this firm is to decrease the costs of fixing its products’ competitive position in the supply market,
the efficiency improvement through reaching to a better supply source for its components and products.
In this firm make or buy decisions usually depend on cost and production capacity indices. Figure 1 shows
the present make or buy decision making trend of the mentioned firm. In this decision making method, strategic
and long term priorities are least emphasized. Regarding the present competitive forces and their resultants
dynamism, the necessity of strategic and long term attitude, as well as the removal of problems of unfaithfulness
to one’s promise and suppliers’ supply disruption is felt.

3.2. Designing a New Algorithm

The Present decision framework of the firm requires the following adjustments
1- In the above mentioned framework, risk has not been considered on the account of losing core
competencies (such as confidentiality of component design or the importance of activity security)
due to outsourcing the component or activity.
2- Supply disruption risk which provides little chance of bargaining is one of the most important risks of
outsourcing, which must be considered in strategic sourcing framework.
3- Unemployment of resources and task force which is the result of an activity or component
outsourcing.
4- When the make costs inside the country and buy costs from the foreign supplier must be compared,
only the short-term costs are considered and transaction costs and hidden costs are ignored.
5- No special computations have been used for the capital return, such as current net value technique,
and the profitability is computed only using simple and approximate computations.
Therefore, the firm needs a decision support modeling methodology to help managers in case of make or
buy decisions at strategic and operational levels.

Fig. 1. The available make or buy decision algorithm of the firm in question.

3.3. The Suggested Strategic Framework

In this framework which has been shown in figure2, the rectangulars and rhombus show the decision
analysis trend and decision criteria, respectively. Regarding the general concept of outsourcing, the starting point
of the process is: (1) is the component strategically important?
In case of the component being strategic, the next question is related to make or buy costs; (2) if make
costs are cheaper than buy costs, does the firm have the ability to make it or should it search the way to make it.
The next question is about the investment; (3) dose component production need investment?; (4) if no investment
is needed, the firm must make it; (5) if the investment is needed, the profitability of the investment must be

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evaluated, to do so, the current net value method can be useful; (6) if the profitability resulted from the investment
is considered positive, the firm must invest and make; (7) if the profitability of the investment is considered
negative, the firm needs to find out whether the supplier is available or not; (8) in case of the absence of the
supplier, the company has no choice but to make it; (9) in case of the existence of suppliers in the market, the
competition among the suppliers must be considered; (10)in case of the existence of exclusive supplier in the
market, the risk of outsourcing must be considered; (11) in case of the existence of high risks in component
outsourcing, the firm itself must attempt to make it; (12) in case of low risk in component outsourcing, the firm
buys it from the supplier; (13) in case of the existence of competition among suppliers, they must be evaluated
and in case of a good and positive evaluation, the firm will make, otherwise the outsourcing risk is re-evaluated;
(14) if the component is not strategically important and the component is produced inside the country, the
availability of the sources must be considered; (15) if the sources are not available, we return to step 2 and the
make or buy cost must be re-considered; (16) if the sources are available, the make or buy costs must be
compared; (17) if buy costs are less than make costs, the firm prefers to buy the component from the foreign
supplier; (18) if buy costs are more, earning the resources must be considered, in case of the resources’ non-
earning, the component is bought from the supplier; (19) if the sources can be obtained, making is started. If the
component is not strategically important and is not made inside the country, the supplier must be looked for; (21)
in case of the existence of a supplier, the component is bought; (22) if the supplier is not available, the process
must be changed and the component must be replaced, since the component in question is neither produced in
the country, nor there is any supplier to provide it.

21-Buy
19-make
Yes

Yes

No

22- Changing 20- Is there any 18- The

process or supplier resources can
specification available? be obtained?

No

No No
Yes Yes
Yes
14- This
process is 16- Purchase cost
15-resources is less than cost of 17-Buy
in-house make?
now? are available?

No No
Yes No
2- Cost of
Strategic analysis of 1-The Yes manufacturing is
2- need to
component is higher than 4-Make
make or buy decision purchasing? invest?
strategic?

Yes
Yes
6-Investment
5- There is a
No and make
good return?

No

Yes Yes No
9- is there 7- Supplier is
competition 8-make
available?
between
suppliers ?

No/ exclusive
supplier

Yes Low Yes

12-evaluation
of supplier 10-risk in 11-make
13-buy outsourcing

Low

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INTERNATIONAL JOURNAL of ACADEMIC RESEARCH Vol. 6. No. 5. September, 2014
4. RESULTS

4.1. Algorithm Implementation

2 components have been selected in this article. The first component has been already made inside the
country and the second component is bought from the foreign supplier. The reason of selecting these
components has been the unreliability which is caused by the exchange ratio, the increase if initial material costs,
and also the supply disruption risk which imposes a huge cost to the firm. These two components have been
named A and B, respectively, due to the confidentiality and protecting these components’ manufacturing
company. The firm has outsourced component B, due to its low demand and also the unjustifiability of having
production facilities inside the country. Now, the demand for these 2 components has reached to the point that too
much dependence on the supplier has become a great concern for the firm. In order to determine and calculate
the make costs of the first component in the country, the optimum yearly capacity and also the required primitive
investment must be found. The following steps have been taken to find the optimum yearly capacity:
 The study of the process flow for the component and listing the required sources to be processed
 The determination of yearly capacity for every machine based on its standard time cycle
 The removal of the entrance of the production line for every demand and the maximum required
production time
 The determination of the required capital for different yearly programed capacities and the estimation of
costs
The information of the estimation of production costs for the 2 components which is now bought from
foreign suppliers have been provided through the technical help of different sellers for the establishment of
production line.

4.2. Decision Making for Component A

The suggested algorithm is used for component A. As was seen in the previous section, this component is
now bought. Table 2 shows some of the required taken steps in the suggested algorithm of figure 2 for the above
component. The detailed explanations of the performed activities have been shown in table 1.

Table 2. The application of decision framework for component A

The taken steps for

criteria
component A in figure 2
Strategic importance of the component
1
The comparison of make
2 and buy decisions
The need for investment
3
The evaluation of the resulted
5 and 6 profitability from investments
Analysis
The huge costs of the component supply disruption, the role of this component in
postponing the goods delivery to the final consumer, and the consumers’
tendency to buy from other rivals were considered due to the strategic
importance. This component was evaluated as medium to high, in terms of the
business environment conditions, the customers’ situations and the opinion of
executive managers in terms of strategic importance
The estimation of make costs obtained from Crystal-Ball simulation software was
compared with the buy costs from the supplier.
The consideration of make steps of the component proved that a part of it could
be made using the present equipment and the other part required buying some
equipment, which was provided by inquiring the prices from the sellers.
In this section, the current valve was computed and it was compared
with buy costs and supply disruption costs resulted from buying. At the end,
the production of the component in the company was preferred to its
buying from the foreign supplier

Having determined the importance and conditions of component A, the considerations continue. The
estimation of production costs was done, having analyzed and studied the time and the process. There was too
much unreliability regarding the estimation of production costs. A set of simulation operations were performed to
identify different production parameters. The maximum required time for component production has been
calculated as follows based on the market demand:

T=Ta/Td(Equation 1)
T= the maximum production time for the component
Ta= the available net time for work
Td= the total demand (customer demand)
T= 9% of the production line efficiency * every hour, 60minutes* every day, 8 hours* 2 shifts a day*
300work days
The total demand of the customer= 6000
T= (259200/60000) = 4.32 minutes

The yearly capacity was calculated in Crystal-Ball software with domain capacity of 20000 to 80000 units
with 10000 times trials. The change of production capacity in the above mentioned domain is followed by the
fluctuations in variable costs of procreation task force costs, company costs, etc. The production cost was
computed in each repetition and the summary of the results of production costs has been shown in diagrams 1
and 2. The optimum capacity has been obtained based on the least costs in about 5000 units in diagram 2. The
least production cost is seen at this level of yearly production capacity. As the simulation results in diagram 1
reveal, the best component make costs happens at the capacity of about 50000 units with the reliability of 51% for
component A. Table 3 also shows the cost means for optimum yearly capacity (5000).

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Table 3. The estimation of the Obtained production costs out of simulation analysis

Component A (with the programmed

component
capacity of 50000 units) (Rial)
The maximum available production time 4.32
Investment in production facilities 105000000
Variable costs
Task force costs 11340
Direct material costs 450000
Fixed costs
Company overheads 36000
Machinery depreciation 3990
The total costs 501330

The decisions regarding making or buying component A are made as follow:

At first, the current production value is computed in terms of make cost means obtained from simulation
during the next 5 years with discount rate of 20%. Then, the current value of buy costs is computed plus its
resultant supply disruption costs. The extraction of the probability of the occurrence and the amount of supply
disruption duration and their costs are considered with the fine of customer belated demand per numbers, for
each component and using simulation. The formulations of make and buy costs can be seen in equation 2, 3 and
4. It is clear that making is preferred to buying, considering the real cost amounts in the firm in question.

Diagram 1: The estimation of component A: production cost using Crystal-Ball simulation software

Diagram 2: The production costs of each component versus the

optimum capacity obtained from the simulation

(Equation 2)
Make cost = the investment amount in the facilities in year 0 + discount ratio of 20% (the first year make
cost * the first year price +…+ the fifth year make cost * the fifth year price)
(Equation 3)
Buy cost= (the first year buy price * the number of first year purchases +…+ the fifth year buy price * the
number of the fifth year purchases) + the supply disruption cost
(Equation 4)
th
The supply disruption cost= the supply disruption mean in the i year* the number of years in the duration
th
in question* the costs of each delay on the basis of the delivery amount in the j time.

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Table 3. The computation of make or buy costs with the discount ratio of 20% in Crystal-Ball software

Base Year Year 1 Year 2 Year 3 Year 4 Year 5 Sum

Construction Construction Construction Construction The total cost of

Initial investment in Construction costs
costs for the costs for the costs for the costs for the fifth building with a
Base Year for the second year
first year third year fourth year year discount ratio of 20%

Construction
1050000000 25500000000 31000000000 37000000000 44500000000 55000000000 108803343621
costs

Cost of order The total cost of

Cost of supply Cost of order in Cost of order Cost of order Cost of order in
in the First building with a
disruption second year in third year in fourth year fifth year
year discount ratio of 20%

Order Costs 1125000000 30000000000 35000000000 42000000000 50000000000 60000000000 12296141975309

Diagram 3. The total buy cost of component A with the discount ratio of 20%

4.3.Decision Making for Component B

The final cost of component B, which is now produced in the company, has been obtained from the final
cost system of the company. The cost of buying this component is calculated through equation 5.
(Equation 5)
Buy cost= the component buy cost from the foreign supplier + the supply disruption cost + the current
portion of hidden costs – selling the current production facilities
The current portion of hidden costs is the unemployment of task force which was active in production
section of this component and the fixed costs which will exist even until the buy decision is made, which should be
included in buy cost. Table 4 shows the decision process for component B, respectively.

Table 4. The decision framework functions for component B

The taken steps for

criterion Analysis
component B in figure 2
Component B, in terms of performance, is one of the final product’s forming
components. Regarding its key role in customer evaluation of the final
1 Strategic importance of the component
product and the opinion of executive managers, it has acquired
a high rank in strategic point of view.
The component production costs are easily calculated due to its production in
the country. In order to calculate buy costs, the hidden costs resulted from
2 Is the make cost less than buy cost? outsourcing and supply disruption risk costs are added to the buy cost and
the selling of the machinery was also considered and at the end, making the
component was preferred to its buying.
Since this product is produced inside the company, there is no need to any
3 The need to investment
special investment in the company’s equipment.
Regarding the fact that the component make cost is less than its buy cost and
4 Making the component
it does not need any investment, the firm decides to make the component

5.CONCLUSION AND SUGGESTION

As was realized, the main aim of this research was to consider the design and re-consideration of the
present algorithm in make and buy decisions in an industrial firm. Considering the current conditions of the
company and also regarding the used algorithm situation, 2 factors of supply disruption risk of component buying
contracts from the suppliers and investment in generating new production capacity to make the component were
investigated. A particular method was suggested and employed in the analysis of investment costs. Therefore, a
new algorithm was created, placing these 2 factors in the current make or buy algorithm, which was more fruitful
in terms of the inclusion of long term and non-operational problems, compared to the first algorithm. The
possibility of trade off and consideration between make and buy decisions has been suggested for each
component. The creation of such a probability provides the novelty aspect of this research.

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In this article, supply disruption risk by the supplier which is the result of the supplier’s opportunistic
behavior was also considered in the calculation which is an important index and has been ignored in the previous
studies (formulation 1).
Besides, when the decision maker intends to outsource the component which is produced in the country
right now, some fixed costs will remain until a certain time, which have to be added to buy costs in order to make
our decisions more realistic. This matter has been regarded in this article.
Considering the obtained results, it is suggested that the firms’ managers use the proposed algorithm in
decision making in case of other components. Regarding the huge amount of the required data and cost
computations, employing a decision support system is required, due to periodic re-considerations in these
decisions. Partial outsourcing can be a sourcing option in the proposed model and making optimum amount
inside and buying from the supplier can also be obtained. The issue of core competence which can significantly
affect the make or buy processes is also suggested to use a quantitative method in determining the core-
competencies, and to do so, Khaled Hafeezs’ articles, especially this one (30) are proposed.

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