10 Strategic Considerations in Make or Buy Decisions

The relevant considerations in make or buy decisions are the same as those of all purchasing decisions. The strategic considerations are as enumerated below:

1. Quality considerations
2. Quantity considerations
3. Cost considerations
4. Service considerations
5. Competence of know-how required
6. Age of the firm
7. Tax considerations
8. Labour union compulsions
9. Emotional Considerations
10. Sub-contracting

1. Quality Considerations in Make or Buy Decision

Compare the quality of the purchased item and the quality that the company could have achieved, had it made on its own. If there is no possibility of a very wide variation, quality considerations do not weigh heavily in reaching a make-or-buy decision. On the other hand, if there is a possibility of very wide variations between the two alternatives, the quality factor becomes crucial in taking a decision either in favour of ‘make’ or in favour of ‘buy ‘.

Before making a decision to make on our own, enough thought should be given to ensure whether the component given to a specialist outside to be produced for us, could be manufactured in a better way by us overcoming technical difficulties, if any. There should be strict adherence to quality control procedures for eliminating the supply of sub-standard components by the supplier.

The organisation should also come forward to provide technical know how to smaller ancillary units to produce the component to desired standards. If the outside supplies are defective, it would jeopardize saleability of an otherwise good finished product. Unpatented designs or processes are generally not entrusted to outsiders to protect business interests by preventing others from copying them for a prolonged period of time.

2. Quantity Considerations in Make or Buy Decision

Quantity is always in a state of flux and it is related with time element, the correct quantity under a given condition at a given time may not be valid at another time under changed circumstances.

Normally, the make decision is taken when the supplies are likely to be too small to interest an outsider. However, it should be considered whether the order can be made big enough to induce outsiders or whether a corresponding large inventory can be maintained to meet production needs.

Quantity required may be so high that either a decision is taken to make it or to split the requirements among several suppliers. However, when a product is made with the help of dyes or patterns, ‘split purchases’ are ruled out totally. Each supplier in such a case cannot be given the dyes or patterns in view of the high costs involved. Thus, a large quantity requirement often has a slant towards make-decisions. On the contrary, an exceptionally large quantity requirement may hamper production of the regular product line. It then becomes prudent to buy from a supplier.

3. Cost Considerations in Make or Buy Decision

Cost has relevance in make-or-buy decisions when all the other factors are equal, or else reasonable cost estimates of the variations should be included to make up for any inequality. For example, let us consider that the quantity and service factors are equal. The decision to make-or-buy rests on a comparison between a known cost and an estimated unknown cost. The known cost is the price charged by the vendor, the unknown estimated cost is the cost of making. If there is only negligible difference between the two costs, the item should be purchased.

In most cases, a known cost is rather more reliable than a slightly lower estimated cost. How is the cost of making estimated? The estimation of the cost accurately becomes difficult when overhead costs are to be allocated on item that is made in the plant from the materials and on the machines being used for other items.

A plant operating at full or near capacity gives a different cost sheet of the item now being purchased than a plant having idle capacity would give. Idle capacity results in a high ratio of fixed costs to total costs. Therefore, additional output can be obtained with only a nominal increase in total cost.

On the other hand, a firm operating at full capacity gives additional output at substantially increased costs. A plant with excess capacity can increase production by merely adding incremental costs that are variable in nature. A plant working at full capacity, however can give additional output only by increasing its capacity. In such a situation, it is right on the part of the company to purchase from outside at any price less than the unit total costs of making the item.

4. Service Considerations in Make or Buy Decision (Assured or Timely Supply)

The guarantee of supply is an important service consideration. Generally, it can be said that supply is more assured when a company makes an item than when it buys. Assured supply to the assembly line is often a reason for making rather than buying. Such decisions are valid for large industrial concerns where uninterrupted supply is necessary to prevent a break-down in the supply line.

One more consideration is about the effect of the make or buy decision is the buyer’s flexibility. While negotiating on buying with various suppliers, the suppliers can be selected as the occasion demands to get the right quality, the right quantity, at the right time and for the right price. Once a company starts making an item on its own, then flexibility is lost.

5. Competence of Know-how required

At any time, a firm wanting to produce an item can acquire the necessary potentialities of making the item. But the feasibility of such acquisition largely depends on the costs which will have to be incurred in acquiring such competence vis-a-vis “buying cost” of the same item. This has to be evaluated and a decision taken accordingly.

6. The Age of Firm

The firm going for ‘a make’ decision must view its decision from its own age point of view. If it is in its infancy, it is better to rely on outside suppliers. Even if a firm is at a developing stage, it may favour a buying decision instead of plunging itself into an uncertain future unless the exigencies of plant and firm’s competence in producing is far superior in all respects and quality, price and service considerations favour the making decision.

7. Tax Considerations in Make or Buy Decision

India is a highly taxed country and the proportion of indirect taxes is till higher. The customs, foreign exchange, import and export restrictions, priority sector subsidies, excise duty are a few examples of tax and restrictive measures which attract the attention of the management when it is posed with a problem of taking a make or buy decision.

Profit is the prime motive behind any management’s decision. Taxes erode profits and thereby leave little incentive to increase profits, if the management decides to take more than a normal risk while taking a decision ‘to make’ and save, thus reducing the cost of production.

8. Labour Union Compulsions in Make or Buy Decision

Sometimes labour unions may be against a decision which they fear might go against their interest. Generally, Making rather than buying items may enable a firm to give more assured and regular employment to its employees.

9. Emotional Considerations in Make or Buy Decision

Motivated by the idea of expansion and enlargement of its activities, the management may go for a make decision. Such an expansion scheme might have come out of economic reasons or emotional or even both but what has to be decided is whether the management can be allowed to go ahead with its purely emotional decision in view of grave implications.

10. Sub-Contracting in Make or Buy Decision

Sub-contracting is a practice wherein the producer hires the services of another producer to perform some of the manufacturing processes or to help in assembling or sub-assembling so as to have the end product at their door-step without going into the formalities of purchasing operations.

Sub-contracting, in other words, is one method of buying instead of making and hence many of the factors discussed above, influence the subcontracting decisions. It may avoid the need for a new plant and equipment on the part of the buyer. Sub-contracting will generally save the buyer from incurring investment costs in specialized machinery and tooling which may not be needed for his regular production requirements.

Advantages of Sub-contracting

1. It is the fastest method of increasing the output.

2. The sub-contractor uses all the facilities and thus succeeds in utilizing the capacity hitherto not being utilized or under-utilized.

3. It helps in avoidance of over-expansion of productive facilities and thus assists in meeting abnormal demand having arisen due to one reason or the other.

4. It helps in saving time because of skill, experience, competency and technical know-how of workmen.

5. During the period of emergency of a nation, when its production capacity should be used to the utmost, sub-contracting offers the best solution.