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Vikram D. Shikhare

Session 9
Make or Buy Decisions

OBJECTIVES
Make

or Buy - rationale Scope Functional analysis Technological dimensions Factor analysis Quantitative techniques

Introduction
Production of all parts and components of main equipment is uneconomical and infeasible.
Production

economy and competitive costing is possible by using modern technology and high volume capacity. critical parts / components may be produced in-house.

Only

Introduction (Continued)

Plant capacity is limited to take care of captive requirements only

In general it is economical to set up a production capacity based on horizontal integration. Manufacture concentrates on technology production and sales and procures the rest from sub-contractors.
All units are engaged in make or buy decisions.

Make OR Buy Decision


Factors

considered in Making a component Location, Layout, capacity, product and process technology, plant and machinery, facilities, production control, quality and maintenance aspects Factors considered in Buying a component What, How, How Much, When, Where and What price? Commonsense approach / in-depth analysis. Data must be available to analyse.

Make OR Buy Decision


Techniques

available

Decision tree Break-even analysis When data is not fully available Statistical techniques forecasting, trend analysis, regression techniques. No analysis can substitute managerial capability and skill

Scope
Covers

all resources

Materials and components Manufacturing capacity Infrastructure facilities Manpower skills Maintenance After-Sales service

Functional analysis
Make

or Buy decisions have short and long term effects on all functions of the organization
Financial Technological Marketing Purchasing Strategic Intangible aspects

Financial aspects
Make

decision requires certain financial investments


Fixed costs Variable costs

Buy

decision has only variable costs All benefits can be converted to financial terms and analyzed. Many techniques available

Technological Aspects
Technological

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dimensions a) Accessibility Latest technology IC circuits have to be bought. b) Exclusive Technology technology transfer agreements - manufacturer has to set up a plant. c) Non-exclusive technology Manufacturer has an option

Technological Aspects continued


d) Technological obsolescence Manufacturers are reluctant to invest and set up a plant. It is prudent to buy design flexible for upgradation to new technology. e) Product Life cycle Product growth stage or at maturity set up capacity to manufacture critical components to reduce cost and improve competitiveness. At declining stage buy components.

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Marketing Aspects
Make

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or Buy decision is dependent on a) Competition In case Severe competition cost and quality important. Make decision provides reliable supply and better quality however cost increases. Trade-off in decision

b) Market share and potential In case of larger market share and future potential, make decision is preferred.

Marketing Aspects
c) End-User govt. departments, defense insist on quality and reliability. Manufacturers prefer to invest in plant and equipment.

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d) Profitability either cut costs or improve sales price and volume. Price in competitive market can be increased only by improved quality / additional features in product. An in-house set up is preferable.

Purchasing Aspects
Option

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to buy depends on -

Availability in right quantity at right time Acceptable quality and price levels
Time

and Quantity

Delay in delivery causes production hold-ups. Early deliveries causes increased cost of carrying inventory. Concept of JIT
Quality

and Price Levels Quality and price are related in practice. The objective of Buy decision will not be realised unless we receive right quality at right price.

Strategic aspects
Make

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or Buy decisions affect Long and Short term plans of business a) Maintaining the aim Objectives of business must be clearly defined and followed. Any diversion from plan will result in objective not being fulfilled. b) Economy of effort Unwise to distribute resources over wide area. Judicious selection of Make or Buy items is necessary.

Strategic aspects

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c) Flexibility As future is uncertain a flexible strategy provides freedom to change the mix of make or buy components. d) Cooperation Between manufacturers and vendors is essential to the success of make-or-buy strategy with give and take on quantity, price, schedule etc.

e) Offensive strategy steps taken to achieve market leadership.


Surprise for competitors Security of ones own technology
Introduce

Strategic aspects

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products of superior technology

Produce in-house or buy from vendors having better technology / in-house R and D to adopt and innovate superior technology.
Security

of technology

Effective steps to deny information to competitors. Patent regimes.

Strategic aspects
f) Self-reliance to protect self-interest and competitive position it is advisable to make critical components instead of buying.

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Intangible Aspects
a) Reliability of vendors in case of Buy and of Plant and machinery / technology in case of Make b) Quality Applicable to both make or buy decisions. c) Technical assistance In case of make decisions technical assistance must be available from Equipment suppliers / collaborators / consultants

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Intangible Aspects
d) Environmental Factors In case of make decision the products/processes must be compatible with existing manufacturing plant environment in terms of noise, vibration, dust, toxic emissions etc. e) Labour acceptance Union / Labour cooperation is vital in case of making of new items and outsourcing of existing items. f) Goodwill with vendors / suppliers / stakeholders influences Make or buy decisions.

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Factor Analysis
Endogenous

factors under control of

organization Exogenous factors Company does not have full control They may be listed in favour of make or buy decisions and their impact evaluated as High , medium and low. These could be tabulated by the decision making committee.

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Factor Analysis Endogenous factors


Sr No Factor Conditions Conditions favouring favouring Buy Make High Low Not available Insufficient

1 2 3

Volume of Production Infrastructure Available Manpower Excess

4
5

Fixed cost
Profitability

Low
High

High
Low

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Factor Analysis - Exogenous factors


Sr No 1 2 3 4 5 Factor Conditions favouring Make Exclusive Long term Unreliable No Good Conditions favouring Buy Non exclusive Short term Reliable Yes Bad

Collaboration agreement Demand of item Reliability of vendors Standard items Labour relations

Quantitative Techniques
These can help managers to evaluate the factors influencing the decisions. They have their own limitations. Cost considerations - Break even analysis Cost Volume analysis Profit considerations Profit volume analysis Use of equal cost chart. Use of Probability Use of decision Tree approach Use of Discounted Cash Flow analysis Use of Net present value method

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1. 2.

3.
4. 5.

6.
7. 8.

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Thank You