Make or Buy decision in materials management
Every firm engaged in the production of one or more type of goods aims at profit maximization. To accomplish this objective, it tries to procure the desired material for the operation of its plant at a low cost. It has usually the alternative of satisfying its requirements by producing the goods or material from within the firm itself.
In some cases, a firm can manufacture materials in the desired quantity at a relatively low cost; but in certain other cases, the procurement of these goods from outsiders is more advantageous. In determining whether goods or material should be purchased or produced within the firm arises the “make or buy” problem.
The policies of the firms vary considerably in make or buy decision considerably. There are certain industries which follow the policy of self-support to the extent of manufacturing all the items required by them. On the other hand, there are concerns which believe in procuring material from other companies that specialize in the manufacture of those items/products.
Every company uses a variety of suppliers and services, they need stationery, cartons, polyethylene bags, detergents, chemicals, power, heat, and many others. But it is not possible for them to procure all of them or produce all of them. They, therefore, take decisions on which items they should make and which goods and services they should buy.
Factors influencing “Make or Buy” decision
The following are some of the factors influencing make or buy decisions.
1. Size of the company influence Make or Buy decision
The size of a concern have a greater influence on Make or Buy decision. The decisions are taken on the basis of their financial implications for a growing concern.
For small companies, with an annual expenditure of a few lakhs of rupees, it is always desirable to buy materials from outside.
In big concerns, where a substantial amount is involved, a full-scale analysis is required covering company matters relating to overall corporate policy, direct cost, personnel relations, plant layout, and other details which are incidental to any manufacturing programme.
2. Difficulties in Manufacturing
Manufacturing may be undertaken to ensure a regular supply. This is specially necessary where a close coordination between demand and supply is required. The decision to make goods appears to be quite attractive from the point of view of self-sufficiency, the high cost of procurement, and the interruptions in deliveries by vendors confronted with labor difficulties or natural calamities. It has been said that the difficulties which manufacturers are trying to avoid to arise even when they buy material for their own production. But the danger is less, for there is a greater assurance of regular supply, when the item is manufactured by the user himself.
3. Quality of goods
In some cases, the decision to make flows from the company’s expectations to have goods of a desired quality. It has been observed that, in a seller’s market, vendors do not bother about quality and specifications. Sometimes they sell only high quality goods and enjoy a profitable sales volume; they do not, therefore, have any interest in lower quality goods which at times may be needed by some manufacturers. In such a situation, the producer has no option but to manufacture the goods himself.
4. Profit factor
There are conditions under which it is profitable for a company to produce certain items more economically than they can be bought from outside. If it discovers a new process which enables it to produce some items at a definitely low cost or if it acquires equipment at a relatively low price that can manufacture goods cheaply, the decision to make goods instead of buying them will be quite profitable.
5. Capacity to manufacture
Capacity of a firm to manufacture materials also affects the make or buy decision. During the period of depression or recession, the manufacturer with idle plant capacity may find it desirable to undertake the production of those goods which they were formerly buying. Even during normal times, the decision to make is taken with a view to increasing the total volume of production. In this way, the overhead costs can be distributed. Sometimes, protection of quality design also tempts companies to make decisions.
Guidelines to “Make or Buy” policy
The following are often an answer to most “make or buy” decisions relating to supplies and services:
1. When a dependable source does not exist outside, it is desirable for the company to produce the goods of the desired quality, unless some unforeseen circumstances develop. For instance, most big companies prefer to have their own thermal supply because public power plants are not reliable.
2. When a dependable source exists outside which provides goods at an economical price, it should be used, unless there is a strong case for not doing so. For instance, under the following conditions, it is always desirable to depend on their own resources:
- When an item is required in large quantities which can be produced at a low cost by the company itself;
- When suppliers are not willing to provide goods of the desired quality or cater to the special needs of their buyers; and
- When coordination with suppliers seems to be quite difficult.