Make or buy entscheidungen: Meaning, Criticisms & Real-World Uses

Make or Buy Decisions

A make or buy decision is the strategic choice a company faces when determining whether to produce a good or service internally or acquire it from an external supplier. This fundamental concept within Supply Chain Management is crucial for optimizing resource allocation, managing production costs, and enhancing overall operational efficiency. The evaluation process typically involves a thorough cost-benefit analysis that considers both quantitative financial metrics and qualitative strategic factors. Businesses frequently encounter make or buy decisions across various functions, from manufacturing components to acquiring specialized services.

History and Origin

The framework for make or buy decisions has evolved over decades, rooted in the broader fields of economics, purchasing, operations research, and strategic management. Early considerations often focused primarily on cost parameters, evaluating whether in-house production or external procurement was more financially advantageous. Over time, the understanding expanded to incorporate strategic dimensions, recognizing that these choices could significantly impact a company's core competencies and long-term viability. Academic research has contributed to developing structured frameworks and tools, helping managers systematically evaluate these complex sourcing dilemmas. For instance, a paper published in the Journal of Industrial Engineering and Management discusses the development of a framework designed to assist managers in evaluating sourcing decisions by updating traditional make-or-buy literature with new academic insights.⁸

Key Takeaways

A make or buy decision is a strategic choice between producing a good or service internally ("make") or purchasing it from an external supplier ("buy").
These decisions are critical for a company's cost structure, operational efficiency, and overall competitive advantage.
The analysis considers both quantitative factors, such as comparative costs, and qualitative aspects like quality control, risk management, and access to specialized expertise.
Factors influencing the decision include existing internal capacity, required capital investment, intellectual property concerns, and market conditions.
Make or buy decisions are not irreversible and should be periodically re-evaluated to adapt to changing business environments.

Formula and Calculation

While there isn't a single universal "make or buy formula," the decision hinges on comparing the total costs of making versus buying. A simplified approach involves calculating the total relevant cost for each option.

Total Cost of Making (TCM):

\text{TCM} = (\text{Direct Materials} + \text{Direct Labor} + \text{Variable Overhead per Unit}) \times \text{Number of Units} + \text{Fixed Overhead}

Total Cost of Buying (TCB):

\text{TCB} = (\text{Purchase Price per Unit} + \text{Variable Costs of Buying per Unit}) \times \text{Number of Units} + \text{Fixed Costs of Buying}

Where:

Direct Materials: Costs of raw materials directly used in production.
Direct Labor: Wages paid to workers directly involved in manufacturing.
Variable Overhead per Unit: Indirect variable costs associated with each unit produced (e.g., electricity for machinery).
Number of Units: The quantity of items required.
Fixed Overhead: Indirect fixed costs associated with in-house production (e.g., depreciation of existing machinery, relevant portion of factory rent).
Purchase Price per Unit: The price charged by the external supplier per unit.
Variable Costs of Buying per Unit: Costs incurred per unit when buying (e.g., inspection costs, transportation per unit).
Fixed Costs of Buying: Fixed costs associated with procurement (e.g., contract management fees, fixed logistics costs).

If (\text{TCM} < \text{TCB}), the decision leans towards making. If (\text{TCB} < \text{TCM}), the decision favors buying. This quantitative analysis forms the foundation, though qualitative factors are also vital.

Interpreting the Make or Buy Decision

Interpreting a make or buy decision extends beyond a simple cost comparison. It involves understanding the broader strategic implications for a business. If the quantitative analysis suggests that "making" is cheaper, it indicates that the company possesses or can efficiently acquire the necessary internal capabilities, potentially leveraging existing idle production capacity or specialized skills. Conversely, if "buying" is more cost-effective, it often signals that external suppliers can achieve greater efficiency, perhaps due to economies of scale or specialized expertise the company lacks.

Beyond cost, interpretation considers how the choice aligns with the company's long-term objectives and risk tolerance. For instance, outsourcing a non-core activity might allow management to focus internal resources on areas that provide a true competitive advantage. Conversely, choosing to make a critical component in-house might be driven by a need for tight quality control or protection of proprietary technology, even if the direct cost is slightly higher. The decision ultimately reflects a balance between financial prudence, operational flexibility, and strategic positioning.

Hypothetical Example

Consider "InnovateTech Inc.," a company specializing in advanced robotics. They need a custom-designed circuit board for their new robotic arm.

Scenario: InnovateTech can either:

Make: Design and manufacture the circuit board in their existing electronics division.
Buy: Source the circuit board from "CircuitWorks Co.," a specialized electronics manufacturer.

Cost Analysis for 10,000 units:

Making (InnovateTech Inc.):

Direct Materials per unit: $10
Direct Labor per unit: $8
Variable Overhead per unit: $2
Allocated Fixed Overhead (due to using existing equipment, not increasing overall fixed costs): $50,000 (This is the additional fixed cost directly attributable to this product, not the total fixed cost of the division if it were not used otherwise).

Total Cost of Making (TCM):

\text{TCM} = ((\$10 + \$8 + \$2) \times 10,000) + \$50,000 \\ \text{TCM} = (\$20 \times 10,000) + \$50,000 \\ \text{TCM} = \$200,000 + \$50,000 \\ \text{TCM} = \$250,000

Buying (CircuitWorks Co.):

Purchase Price per unit: $23
Variable Costs of Buying per unit (e.g., inspection, minor logistics): $1
Fixed Costs of Buying (e.g., initial contract negotiation, supplier management): $10,000

Total Cost of Buying (TCB):

\text{TCB} = ((\$23 + \$1) \times 10,000) + \$10,000 \\ \text{TCB} = (\$24 \times 10,000) + \$10,000 \\ \text{TCB} = \$240,000 + \$10,000 \\ \text{TCB} = \$250,000

In this specific hypothetical example, the quantitative analysis shows both options have the same total cost of $250,000. This parity suggests that InnovateTech must rely heavily on qualitative factors for its final decision-making. For instance, if protecting the intellectual property of their robotic arm's functionality is paramount, making the circuit board in-house might be preferred. Conversely, if CircuitWorks Co. offers a faster production timeline or superior technical support, buying could be the better choice despite the equal cost.

Practical Applications

Make or buy decisions are ubiquitous in the business world, spanning various industries and operational scales. In manufacturing, companies routinely decide whether to produce components in-house, such as engine parts for an automobile or microchips for electronic devices, or to procure them from specialized suppliers. This choice directly impacts a firm's vertical integration strategy. Beyond physical goods, service-oriented businesses also face these decisions; for example, a marketing firm might decide whether to employ an in-house graphic design team or outsource design projects to external agencies.

These decisions are particularly prominent in the context of global supply chains. Factors such as access to raw materials, labor costs, and geopolitical stability can heavily influence whether production is kept local or moved offshore. Modern trends in supply chain management, such as those highlighted in reports from Deloitte, indicate a growing emphasis on resilience and agility in sourcing strategies due to disruptions from global trade tensions and raw material shortages.⁷ Businesses are increasingly evaluating their capabilities to meet production demands and assessing potential risks like transportation disruptions or supplier failures.⁶ The decision to "make" can offer greater control over quality control and production timelines, while "buying" can provide access to specialized expertise, increased flexibility, or cost advantages by leveraging economies of scale.

Limitations and Criticisms

While make or buy decisions offer a structured approach to resource allocation, they come with inherent limitations and criticisms. A primary challenge lies in accurately estimating and comparing all relevant costs. Often, indirect or overhead costs of in-house production are difficult to quantify fully, and external supplier costs might not always be transparent, potentially leading to hidden fees or unforeseen contractual complexities. Furthermore, decisions made solely on current cost data may neglect future market shifts, technological advancements, or changes in internal capabilities.

Qualitative factors, while critical, can also be subjective and challenging to weigh consistently. Assessing the reliability of a supplier, the long-term impact on employee morale, or the true value of maintaining intellectual property can introduce biases into the decision-making process. Research, including insights published by the Harvard Business Review, points out common pitfalls in high-stakes decision-making, such as an unrealistic search for "silver-bullet" solutions or a failure to consider alternatives explicitly.⁵ A company might, for instance, underestimate the challenges of change management associated with shifting from in-house production to outsourcing, or vice versa, leading to operational disruptions or a deterioration of internal skills.⁴ Over-reliance on outsourcing for core functions can also lead to a loss of internal expertise and a heightened dependency on external vendors, potentially eroding a firm's long-term competitive advantage.

Make or Buy Decisions vs. Outsourcing

While often used interchangeably, "make or buy decisions" and "outsourcing" represent slightly different concepts. A make or buy decision is the fundamental strategic choice an organization faces regarding how to acquire a needed good or service. It's the initial evaluation phase where a company assesses whether to produce something internally ("make") or obtain it from an external source ("buy").

Outsourcing, on the other hand, is a result or subset of a "buy" decision. Specifically, outsourcing refers to the practice of contracting out a business process or function (such as manufacturing, IT services, or customer support) to a third-party provider, often to reduce costs or focus on core competencies. All outsourcing is a "buy" decision, but not all "buy" decisions involve outsourcing an entire business process. For example, purchasing raw materials or off-the-shelf components from a supplier is a "buy" decision, but it's typically not referred to as outsourcing. The confusion arises because both involve external procurement, but outsourcing implies a more comprehensive delegation of a function or process.

FAQs

What factors should be considered in a make or buy decision?

Key factors include production costs (direct and indirect), available internal capacity and expertise, quality control requirements, strategic importance of the item, potential risk management implications, and the protection of intellectual property.

Are make or buy decisions irreversible?

No, make or buy decisions are generally not irreversible. Companies can, and often do, reverse these decisions if market conditions change, internal capabilities evolve, or supplier performance falters. Periodic review is essential to ensure the chosen strategy remains optimal.³,

How does technology impact make or buy decisions?

Technology, particularly advanced analytics and digital tools, significantly impacts make or buy decisions by providing more accurate cost estimations, simulating various production or procurement scenarios, and offering better insights into supplier performance and market trends.² This enhanced data enables more informed choices.

What are the main benefits of making a product in-house?

Making a product in-house can offer greater control over quality, production schedules, and proprietary technology. It can also leverage existing idle production capacity and maintain internal expertise and skills within the organization.

What are the potential drawbacks of buying from an external supplier?

Potential drawbacks of buying from an external supplier include reduced control over quality, potential supply chain disruptions, increased dependence on the supplier, and the risk of compromising intellectual property. It may also involve additional costs for supplier management and communication.¹