Q 1. Compare strategic level analysis & Operational level analysis for Make or Buy decision
The make-or-buy decision is the act of making a strategic choice between
producing an item internally (in-house) or buying it externally (from an outside
supplier). The buy side of the decision also is referred to as outsourcing. Make-or-
buy decisions usually arise when a firm that has developed a product or part–or
significantly modified a product or part–is having trouble with current suppliers,
or has diminishing capacity or changing demand.
Make-or-buy analysis is conducted at the strategic and operational level.
Obviously, the strategic level is the more long-range of the two. Variables
considered at the strategic level include analysis of the future, as well as the current
environment. Issues like government regulation, competing firms, and market
trends all have a strategic impact on the make-or-buy decision. Of course, firms
should make items that reinforce or are in-line with their core competencies. These
are areas in which the firm is strongest and which give the firm a competitive
advantage.
The increased existence of firms that utilize the concept of lean manufacturing
has prompted an increase in outsourcing. Manufacturers are tending to purchase
subassemblies rather than piece parts, and are outsourcing activities ranging
from logistics to administrative services. In their 2003 book World Class Supply
Management, David Burt, Donald Dobler, and Stephen Starling present a rule of
thumb for out-sourcing. It prescribes that a firm outsource all items that do not fit
one of the following three categories: (1) the item is critical to the success of the
product, including customer perception of important product attributes; (2) the
item requires specialized design and manufacturing skills or equipment, and the
number of capable and reliable suppliers is extremely limited; and (3) the item fits
well within the firm’s core competencies, or within those the firm must develop to
fulfill future plans. Items that fit under one of these three categories are considered
strategic in nature and should be produced internally if at all possible.
Make-or-buy decisions also occur at the operational level. Analysis in separate
texts by Burt, Dobler, and Starling, as well as Joel Wisner, G. Keong Leong, and
Keah-Choon Tan, suggest these considerations that favor making a part in-house:
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Cost considerations (less expensive to make the part)
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Desire to integrate plant operations
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Productive use of excess plant capacity to help absorb fixed overhead (using
existing idle capacity)
Need to exert direct control over production and/or quality
–
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Better quality control
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Design secrecy is required to protect proprietary technology
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Unreliable suppliers
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No competent suppliers
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Desire to maintain a stable workforce (in periods of declining sales)
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Quantity too small to interest a supplier
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Control of lead time, transportation, and warehousing costs
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Greater assurance of continual supply
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Provision of a second source
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Political, social or environmental reasons (union pressure)
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Emotion (e.g., pride)
Factors that may influence firms to buy a part externally include:
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Lack of expertise
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Suppliers’ research and specialized know-how exceeds that of the buyer
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cost considerations (less expensive to buy the item)
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Small-volume requirements
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Limited production facilities or insufficient capacity
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Desire to maintain a multiple-source policy
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Indirect managerial control considerations
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Procurement and inventory considerations
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Brand preference
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Item not essential to the firm’s strategy
The two most important factors to consider in a make-or-buy decision are cost
and the availability of production capacity. Burt, Dobler, and Starling warn
that “no other factor is subject to more varied interpretation and to greater
misunderstanding” Cost considerations should include all relevant costs and be
long-term in nature. Obviously, the buying firm will compare production and
purchase costs. Burt, Dobler, and Starling provide the major elements included in
this comparison. Elements of the “make” analysis include:
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Incremental inventory-carrying costs
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Direct labor costs
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Incremental factory overhead costs
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Delivered purchased material costs
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Incremental managerial costs
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Any follow-on costs stemming from quality and related problems
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Incremental purchasing costs
–
Incremental capital costs
Cost considerations for the “buy” analysis include:
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Purchase price of the part
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Transportation costs
–
Receiving and inspection costs
–
Incremental purchasing costs
–
Any follow-on costs related to quality or service
One will note that six of the costs to consider are incremental. By definition,
incremental costs would not be incurred if the part were purchased from an outside
source. If a firm does not currently have the capacity to make the part, incremental
costs will include variable costs plus the full portion of fixed overhead allocable to
the part’s manufacture. If the firm has excess capacity that can be used to produce
the part in question, only the variable overhead caused by production of the parts
are considered incremental. That is, fixed costs, under conditions of sufficient idle
capacity, are not incremental and should not be considered as part of the cost to
make the part.
While cost is seldom the only criterion used in a make-or-buy decision, simple
break-even analysis can be an effective way to quickly surmise the cost
implications within a decision. Suppose that a firm can purchase equipment for in-
house use for $250,000 and produce the needed parts for $10 each. Alternatively,
a supplier could produce and ship the part for $15 each. Ignoring the cost of
negotiating a contract with the supplier, the simple break-even point could easily
be computed:
$250,000 + $10Q = $15Q
$250,000 = $15Q − $10Q
$250,000 = $5Q
50,000 = Q
Therefore, it would be more cost effective for a firm to buy the part if demand
is less than 50,000 units, and make the part if demand exceeds 50,000 units.
However, if the firm had enough idle capacity to produce the parts, the fixed cost
of $250,000 would not be incurred (meaning it is not an incremental cost), making
the prospect of making the part too cost efficient to ignore.
Stanley Gardiner and John Blackstone’s 1991 paper in the International Journal of
Purchasing and Materials Management presented the contribution-per-constraint-
minute (CPCM) method of make-or-buy analysis, which makes the decision
based on the theory of constraints. They also used this approach to determine
the maximum permissible component price (MPCP) that a buyer should pay
when outsourcing. In 2005 Jaydeep Balakrishnan and Chun Hung Cheng noted
that Gardiner and Blackstone’s method did not guarantee a best solution for a
complicated make-or-buy problem. Therefore, they offer an updated, enhanced
approach using spreadsheets with built-in liner programming (LP) capability to
provide “what if” analyses to encourage efforts toward finding an optimal solution.
Firms have started to realize the importance of the make-or-buy decision to
overall manufacturing strategy and the implication it can have for employment
levels, asset levels, and core competencies. In response to this, some firms have
adopted total cost of ownership (TCO) procedures for incorporating non-price
considerations into the make-or-buy decision.
Q 2. Write short notes on the following:
a. Design, Bid, Build (D-B-B) methodology
Design-bid-build (or design/bid/build, and abbreviated D-B-B or D/B/B
accordingly), also known as Design-tender (or “design/tender”) and Traditional
Method, is a project delivery method in which the agency or owner contracts with
separate entities for each the design and construction of a project.