SMU MBA ASSIGNMENTS

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

 

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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

 

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Receiving and inspection costs

 

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Incremental purchasing costs

 

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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.