Chapter 5

Make or Buy, Insourcing, and Outsourcing

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 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?

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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

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Reasons to Make Instead of Buy (1 of 2)
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
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Reasons to Make Instead of Buy (2 of 2)
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
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 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?

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The Outsourcing Matrix

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 Reasons to Insource (1 of 2)

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.”

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 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
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 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.”

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 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

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 Service Triads (1 of 2)

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

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Service Triads (2 of 2)

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 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

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The Outsourcing Decision

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 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

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 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

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