Chapter 5

Make or Buy, Insourcing, and

Outsourcing

©2020 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or
further distribution permitted without the prior written consent of McGraw-Hill Education.
 Key Questions Asked in Chapter 5

– Should we make or buy a good or service?

– If we have been making a good or service

should we reverse the decision and
outsource?

– If we have been buying, should we reverse

the decision and insource?

©2020 McGraw-Hill Education. 2

 Make or Buy, Insourcing,
and Outsourcing Decisions
What Product / Service to Create
in What Market Segment(s)?

What Do We Make or Buy?

100% 100%
Gray Zone
Make Buy

Stay Change Stay Change Stay Change

Outsource Insource
More More
Make Buy
Gray 100% Insource Outsource Gray 100%
Zone Buy Zone Make

100% Gray 100% Gray

Make Zone Buy Zone

©2020 McGraw-Hill Education. 3

 Reasons to Make Instead of Buy
• Quantities are too small and/or no supplier is interested
• Quality requirements are too exacting or special processing
methods needed
• Greater assurance of supply
• Preserve technological secrets and intellectual property
• Lower cost
• To take advantage of unused capacity
• Keep our capacity utilization high and outsource the rest
• Avoid supply dependency
• Reduce risk
• Purchase option too expensive
• Distance from the closest available supplier is too great
• Customer requirement
• Future market potential for the product or service is expanding
• Forecasts of future shortages in the market or rising prices
• Management takes pride in size
• Desire to control quality of customer service
©2020 McGraw-Hill Education. 4
 Reasons to Make Instead of Buy
• Lack of managerial or technical experience
• Excess production capacity
• Reduce risk
• Challenges of maintaining technological leadership for noncore
activity
• Outsourcing is difficult to reverse
• Cost accuracy
• Large number of options for sources of supply and substitutes
• Insufficient volume to justify in-house production
• Forecasts show great demand and/or technological uncertainty
• Availability of a highly capable supplier
• Flexibility and desire to stay lean
• Buying may open up markets
• The ability to bring a product or service to market faster
• Customer preference for a particular brand
• Superior supply management expertise
• Opportunities to improve customer service

©2020 McGraw-Hill Education. 5

 Insourcing and Outsourcing

• Two ongoing questions for a cross-functional

team including supply, operations, accounting
and marketing are:

(1) Which products or services are we currently

buying that we should be doing in-house?

(2) Which products and services that we are

currently doing in-house should we be buying from
suppliers?

©2020 McGraw-Hill Education. 6

 The Outsourcing Matrix

Currently Currently
In-House Outsourced

Should Be 1 2
In-House

Should Be
3 4
Outsourced

©2020 McGraw-Hill Education. 7

 Reasons to Insource

• The necessity argument: “We would prefer not to

produce this product or service in-house, but we
really don’t have any other options.”

• The opportunity argument: “We would prefer to

do this in-house because it would give us a
strategic competitive advantage.”

©2020 McGraw-Hill Education. 8

 Examples of Necessity
Drivers of Insourcing
• Anything that threatens assurance of supply
– An existing source of supply goes out of business or drops
a product or service line and no other supplier is available
– No opportunities for supplier development
– A sudden massive increase in price
– The purchase of a sole source by a competitor
– Political events and regulatory changes
– Lack of supply of a key raw material or component
required for the manufacture of the purchased product

©2020 McGraw-Hill Education. 9

 Reasons to Outsource

• The necessity argument: “We would prefer not to

outsource this product or service, but we really
don’t have any other options.”

• The opportunity argument: “We would prefer to

outsource this product or service because it
would give us a strategic competitive
advantage.”

©2020 McGraw-Hill Education. 10

 Deciding What Might be Outsourced

• Determine strategic, critical, non-core activities

• An entire function or some elements of an activity

may lend themselves to lower cost purchase and
management by a third party

• Identify a function as a potential outsourcing target,

break that function into its components, determine
which activities are strategic or critical and should
remain in-house, and which can be outsourced

©2020 McGraw-Hill Education. 11

 Service Triads
• Increasing prevalence of service outsourcing
based upon triadic servicing arrangements
• Service triads:
– buyer contracts with a supplier to deliver services
directly to the buyer’s customer
– examples: outsourcing help desk services, repair or
installation of customer equipment
• Increasing use of performance-based contracts
that focus on the outcome rather than controlling
how the service is delivered

©2020 McGraw-Hill Education. 12

 Service Triads

Customer

Buyer Supplier

Servicing demand and financial flows

Servicing exchange

©2020 McGraw-Hill Education. 13

 Risks of Outsourcing
• Loss of control
• Exposure to supplier risks
– e.g., financial, commitment to relationship, response
time, quality, service
• Unexpected/unanticipated costs
• Difficulty quantifying economies
• Conversion costs
• Supply restraints
• Attention required by senior management
• Possibility of being tied to obsolete technology
• Concerns with long-term flexibility

©2020 McGraw-Hill Education. 14

 The Outsourcing Decision
Yes Keep the function
Is the activity strategic?
in-house
No
Is the activity critical to the Yes Keep the function
business but not strategic? in-house
No
Create a RFP.
Gather supplier bids/proposals.
No
Is the supplier’s bid/proposal more Yes Keep the function
desirable than the internal option? in-house
No
Could the internal option achieve Yes Keep the function
similar results? in-house
No
Negotiate a contract to ensure
that expectations are realized

©2020 McGraw-Hill Education. 15

 Outsourcing Supply and Logistics
• Procurement of indirect or noncore spend is more likely
to be outsourced than procurement of direct or core
spend
• Three types of procurement outsourcing contracts:
procure-to-pay (P2P), source-to-contract (S2C), source-
to-pay (S2P)
• Most frequently outsourced logistics activities are
transactional, operational and repetitive
– e.g., transportation, warehousing and freight
forwarding
• Three reasons for outsourcing logistics activities:
improved services, reduced costs, increased ability to
focus on core competencies

©2020 McGraw-Hill Education. 16

 Purchasing’s Role in Outsourcing

• Provide a comprehensive, competitive process

• Identify opportunities for outsourcing
• Aid in selection of sources
• Identify potential relationship issues
• Develop and negotiate contract
• Monitor and manage relationship

©2020 McGraw-Hill Education. 17