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Make or buy decisions


When it comes to deciding whether or not to outsource production, it is best to keep the following in mind - "Do what you do best and outsource the rest". This may sound simple, but in today's competitive landscape, it is a decision that is not and should not be taken lightly.

Businesses are born because the founders believe they have a better way to meet customer needs; however, not all functions within a firm are critical to those needs. The ones that are critical are defined as 'core activities' and should be retained in the business under its direct control, as these provide strategic advantage. Understanding the 'core competencies' that make a firm unique is a critical step in any make-or-buy decision, because these are the activities on which a firm should focus its internal operations. All non-essential services should then be outsourced.

The decision-making process related to outsourcing starts with an evaluation of what a firm 'will make', against what it 'will buy'. Managers should analyse the production process to decide which functions their staff will perform and which functions can be better, and more cost-effectively accomplished, by one or several suppliers. It is critical that the make-or-buy decision is based upon a calculation of total costs for any function, even if these costs are difficult to quantify.

To assess the costs and benefits of outsourcing a particular function, all of the related costs that accrue from the production or delivery of the goods or service in-house must be taken into account. As an outsourcing decision relates to future expenditures, the firm should compare the expected future costs associated with supplying the goods or service from within the organisation, with those of purchasing the goods or service externally. As part of this process, the liquidity and cash flow position of the firm should also be considered.

In addition, other financial questions should be asked about outsourcing a function:

  • What is the level of the initial investment?
  • What are the operational costs?
  • How will outsourcing affect fixed and variable costs?
  • Are there hidden additional costs, such as customs duties?

Outsourcing is not purely a quantitative or financial decision; there are also significant qualitative factors to be considered, which may prove more important:

  • Is there a relationship of trust and loyalty between the firm and its outsourcing partners, which will allow information to be shared with confidence?
  • Is the outsourcing partner reliable and has it a successful track record in terms of delivery, efficiency and management?
  • How do the skills and practices of the two firms compare?
  • Is the technology used in the product or the manufacturing process used throughout the industry, or is it proprietary?

Successful outsourcing can create significant long-term benefits and yield cost savings in both operations and distribution. However, there are dangers if the planning and research process is not conducted effectively. Having outsourced a function or activity, it may be difficult to re-establish that function within the organisation without incurring high additional costs.